Fixed Income Securities: Definition, Types, Benefits and Risks Involved

What are Fixed Income Securities in India?

Fixed income securities refer to debt instruments that offer a fixed interest income on your investment. The corpus value that one will get post maturity of the securities is known in advance. Because of this, risk-averse investors prefer fixed income securities over market-linked securities; these securities are apt for such people who want to earn steady returns as well.

Also, some of the fixed income securities like government bonds, treasury bills are backed by the government which ensures minimal chances of default.

Types of Fixed Income Securities

• Debt Mutual Funds

Debt Mutual funds pool in resources from investors and invest the corpus primarily in various debt instruments such as bonds, fixed income securities,etc. Investment in these instruments ensures fixed returns for the investor. Also, these funds invest in debt securities with good credit ratings. The chances of default of payment on these securities are miniscule.

Compared to equity-oriented mutual funds, debt funds are relatively less risky, therefore perfectly suitable for risk averse investors.

To know more about debt mutual funds, please visit: Debt Mutual Funds

• Bonds

Bonds are fixed income securities that are issued by corporations and the government, to raise money for business expansion or financing new projects. They are issued at a discounted price on their face value and can be traded in the secondary market. Thus, an investor earns guaranteed profit, as the bonds are redeemed at the face value upon maturity.

• Bank Fixed Deposits (FD)

Bank fixed deposits are one of the most popular investment options available in India. A fixed deposit account essentially offers fixed interest rate on your principal investment. This fixed-income security is offered by almost every scheduled bank in India. Numerous investors in India have availed the benefits of Bank FD.

An investor makes a lump-sum principal investment that earns interest during the deposit period. At maturity, the investor gets the principal and the accrued interest.

Different banks provide fixed deposit accounts with different maturities. Investors can opt for FD accounts with maturity period ranging from 7 days to 10 years.

Also Read: Fixed Deposits (FDs)

• Treasury Bills

Treasury bills or T- Bills are issued by the Central Government for raising money. They have short term maturities with the highest upto one year. Currently, T- Bills are issued with 3 different maturity periods, which are, 91 days T-Bills, 182 days T- Bills, 1 year T – Bills.

T-Bills are issued at a discount to the face value. At maturity, the investor gets the face value amount. This difference between the initial value and face value is the return earned by the investor. They are the safest short term fixed income investments as they are backed by the Government of India.

• Recurring Deposits

Recurring deposits are similar to SIP Investment in Mutual funds. An individual deposits a small amount of money as a monthly installment for a fixed duration that ranges from 1 year to 10 years in a recurring deposit. The interest rate is the same as that of fixed deposits.This enables retail investors with small amounts of money to generate a good corpus of wealth in the long run.

Also Read: Recurring Deposits (RD)

• Repurchase Agreements

Also known as repos or buybacks, Repurchase Agreements are a formal agreement between two parties, where one party sells a security to another, with the promise of buying it back at a later date from the buyer. It is also called a Sell-Buy transaction.

The seller buys the security at a predetermined time and amount which also includes the interest rate at which the buyer agreed to buy the security. The interest rate charged by the buyer for agreeing to buy the security is called Repo rate. Repos come-in handy when the seller needs funds for short-term, s/he can just sell the securities and get the funds to dispose. The buyer gets an opportunity to earn decent returns on the invested money.

• Banker’s Acceptance
  

A financial instrument produced by an individual or a corporation, in the name of the bank is known as Banker’s Acceptance. It requires the issuer to pay the instrument holder a specified amount on a predetermined date, which ranges from 30 to 180 days, starting from the date of issue of the instrument. It is a secure financial instrument as the payment is guaranteed by a commercial bank.

Banker’s Acceptance is issued at a discounted price, and the actual price is paid to the holder at maturity. The difference between the two is the profit made by the investor.

Why Invest in Fixed Income Securities?

If your financial goals involve earning steady returns coupled with low risk, fixed income securities are the best investment option available in the market. Compared to investment in equities, returns from these securities might be low but they are guaranteed.

If you’re an active investor, investment in fixed income securities will diversify your portfolio and yield returns even during turbulent market swings. This reduces the overall risk of the investment portfolio.

Some of the fixed income securities in India have tax saving options available, which serves as another incentive for investment in these securities.

Risks of Investing in Fixed Income Securities

• Interest Rate Risk:

  Changes in interest rates affect the bond prices, and consequently the returns from debt mutual funds. If the interest rates rise, bond prices fall  and vice versa. This is known as interest rate risk.

• Credit Risk:

  Debt mutual funds invest in debt securities such as treasury bills, corporate bonds, etc. Credit risk arises when the issuer of the bond or debt security defaults on the timely payments of interest and the principal amount. To mitigate credit risk, it is advisable to invest in those mutual funds that invest in securities with high credit rating.

Benefits of Investing in Fixed Income Securities

• Stable Returns

  One of the primary benefits of investing in fixed income securities is the stability of returns that they offer. Since these instruments have a fixed interest rate, the returns delivered by them are more or less steady. This makes them a comparable alternative to bank savings accounts which give a minimal interest rate on your deposits.

• Safety of Investment

  The invested capital in a fixed income security is at lower risk when compared to investment in equities. As some of these instruments, such as treasury bills or government bonds, are backed by the government, the chances of defaulting on the payment of interest and principal is almost zero. Also, if the instrument is highly rated by the credit rating agencies such as CRISIL, the possibility of an investor incurring a loss is minuscule. This makes fixed income financial instruments, one of the safest investment avenues available in the market.

• Portfolio Diversification

  Investment in fixed income securities offer a much needed diversification to a concentrated portfolio of equities. It is a well-known fact that equities deliver much higher returns than debt securities, however the volatility of returns delivered by the former is much higher than that of the latter. To make your overall portfolio returns stable, it is imperative that you make a significant investment in highly rated debt securities.

• Priority during Liquidation

  When the company files for bankruptcy and goes for liquidation, it is liable to pay back to its debtors and stock holders. However, it might not have enough assets to pay off both. In that case, lenders of the company, who hold corporate bonds of the firm get priority over those who hold equity. This is one more reason why debt securities are considered to be a safe investment avenue.

FAQs

Ques. What is the difference between equity and fixed income securities?

Ans. Equity securities are the ones that invest in equity shares of an organization whereas fixed income securities are the ones that invest in debts, bonds and other related securities. Equity investments involve higher risk and tend to offer higher returns as they depend upon the fund’s performance. On the other hand, fixed income securities involve lesser risk and offer fixed returns.

Ques. Are fixed income securities liquid?

Ans. Yes. Most of the fixed income securities can be considered liquid. For instance, securities such as Government Bonds, Treasury Bills, Debt funds, FDs, RDs, etc. can be taken as instruments of high liquidity.

Ques. What does Fixed Income mean in a portfolio?

Ans. Investments in fixed income securities are known to bring diversification to an investor’s portfolio. While equity securities in a portfolio tend to deliver high returns; fixed income securities, on the other hand, balance the risk involved in a portfolio due to equities.

Ques. Is fixed income safe?

Ans. Yes, fixed income securities are considered safe investments as they invest only in instruments that offer fixed income. Most of the fixed income securities are also backed by the Government, which reduces the overall risk involved.