What does Fixed Income mean?
• Fixed income refers to any type of investment security which is not equity and that obligates the issuer to make periodic or fixed payments to the purchaser/holder. If you lend money to a borrower and the borrower is required to pay interest once a quarter, you have entered into a fixed-income agreement.
• Common fixed income instruments include the majority of investments who offer the holder a fixed rate of return that is either guaranteed or considered less risky than owning stocks or derivatives. Common examples of fixed income instruments include: bonds (both corporate and government issued), treasury bills, CDs, commercial paper etc.
• A government body will issue bonds or fixed income instruments as a means to increase financing in the short term; the money obtained from investors or citizens purchasing the bonds is used to pay-off debts or fund public supplies. In turn, the holder of the bond enjoys fixed interest payments attached to a guarantee that their principal will be paid in full when the bond matures.
• Companies can also issue fixed-income instruments, such as corporate loans or corporate bonds for the same purpose. These bonds, similar to government bonds may also be traded between investors on an open exchange format.
How does a Fixed Income Security contrast with an Equity?
• A fixed income security contrasts with equity securities—assuming the equity does not pay a dividend—because the rate of return is unexpected with a stock. As a result, the term “fixed” income refers only to the schedule of obligatory payments, delivered by the issuer to the bond or debt holder. A fixed income security may dependent on a variable interest rate, therefore necessitating a difference in the rate of pay, but still maintaining the schedule of payments.
• If an issuer of a fixed-income security goes in default or misses a payment, the bond’s holder can force the underlying company or government agency into bankruptcy. In contrast, for a stock, if a company misses a quarterly dividend payment, there is no violation of the payment covenant and no presence of a default.
Terms Associated with Fixed-Income Instruments:
• The following terms are commonly associated with bonds or other fixed-income securities:
o The Issuer: Refers to the entity, such as a company or government agency, who borrows any amount of money (the forma l issuance of the fixed-income security) and promises to pay interest.
o The Principal: Also referred to as the maturity value, par value or face value, the principal amount is the amount of money the issuer borrows from the lender; the principal must be repaid to the lender when the bond matures
o The Coupon: Refers to the interest rate attached to the bond.
o The indenture: Refers to the contract attached to the fixed income agreement; the indenture will state all the terms of the bond.
o The maturity: Refers to the date at which the bond is redeemed; on this date the issuer is required to return the principal to the holder.