When a government, or a company, needs capital, it can issue debt securities and fixed income instruments (like bonds) to raise the necessary funds.
When you buy bonds and other fixed income products, or hybrid securities, you’re lending money to the issuer (the government or the company that issues the bond). They then agree to pay you interest in return for the loan, until the maturity date. The riskier the loan is (the more doubt there is that the issuer can repay the debt) the more fixed income investors (bond holders / security holders) benefit from higher interest payments (coupon rates). The higher the risk, the more the company must pay in interest (the coupon rate) to secure the loan.
Can you sell a bond before the maturity date?
Selling a fixed income product or bond before it matures means you’ll get market value instead of face value.
Market value can be lower or higher than face value and is influenced by:
- Credit risk of the issuer
- Level of liquidity
- Interest rate movements
- Maturity Date
What are the different types of fixed income investments?
A government or treasury bond refers specifically to a bond (that acts as a loan) issued by governments. As an investment product second only to cash at the bottom of the risk spectrum, they have very low-risk attached and low but predictable yields.
A corporate bond is a bond issued by a corporation or private company.
These bonds are more risky than government bonds, which means they generally pay a higher rate of interest than government bonds.
There are many other fixed income products (securities) that act in a similar fashion to bonds, in that they provide predictable coupon payments and a set maturity date.
Market-linked securities, hybrid securities and bond linked securities are just a few examples of other fixed income instruments.
You can grow your wealth without taking on unnecessary risks
There is a lot of discussion about the yield, return and capital gain of an investment, with no talk about the risk that people are taking to achieve it. The truth is, unless you are on the inside, it is very difficult to know exactly what risks you are taking on. There have been many fortunes lost because the promise of a great return (or modest one) from an investment later backfired and the risk of loss became a reality. With a little more knowledge on how to invest the right way, you can begin to grow your wealth without taking on unnecessary risks.
In finance. the focus on yield and return often misdirects you away from the real question you should be asking: what is the risk I am facing? The finance industry is built around risk. Banks buy and sell risk every day. They are very good at it and will sell you a high-risk product and make you pay more for that risk than they do. It’s important to remember that an investment with a modestly greater return may come with a significantly greater risk. Think of stock yields. Investors know what dividend yield their stocks have. but don’t know whether a company plans to stop their dividend. Companies such as ANZ, CBA, NAB,
Westpac, Qantas, and BHP have reduced or even stopped their dividends at some point before, and can do it again without warning. If this happens and you need to sell the stock to pay for your living expenses previously covered by the dividend, you will be selling at a price far lower than where it was before the dividend was stopped.
Banks understand this risk, which is why they don’t make their money in the stock market. They make their money by loaning money and managing the associated risk. As an individual, those loans may be used to buy an asset such as a house. To a business or directly to governments and corporations, it can be through bonds. And it’s the bond market where the individual investor has been shut out for decades that the banks make the most profit at the lowest risk. That is, until now.
Looking to speak to an investment adviser about how fixed income securities work?
*Data accurate as at 06.12.2024
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