What are Fixed Income Securities?
Fixed income securities used to be a relatively obscure part of the financial markets. Up until the late 1970s, bond markets were used by wealthy individuals, corporations, and even governments to park large sums of money in low-risk-low return securities. Since these bonds were mostly issued by sovereign authorities, they were considered to be one of the safest forms of investment. Also, since the world was on the gold standard, bond markets were generally not impacted by currency fluctuations and inflation concerns.
However, a lot has changed in the forthcoming decades. It is important to realize that the world has gone off the gold standard which means that the government can print as much money as it wants without having anything to back up the currency. This can lead to varying rates of inflation depending upon government policies. Since inflation eats into the value provided by fixed-income securities, varying rates of inflation also mean varying rates of return for fixed-income investors. Hence, going off the gold standard converted the dull fixed income market into a thriving market where speculators can make fortunes.
Today, fixed income markets are considered to be the most powerful market in the world. The volume of trading in the bond market is so huge that stock market volumes seem pale in comparison. Hence, it is important for every investor to have a good understanding of how fixed income securities work.
Fixed income securities can theoretically be of two types. They can either be bonds which are defined as debt which the company owes to outsiders. Or, it could be preferential shares that the company owes to its own investors. Preferential shares are equity shares and hence do not represent the claim of outsiders. For the most part, the term fixed income securities is commonly used to refer to bonds.
- The defining feature of the fixed income securities is that the nominal value which will be paid by the securities remains the same. However, it also means that investors holding fixed income securities have a superior claim on the assets of the organization. This means that in the event of liquidation, fixed income securities will be paid before any other stakeholder is paid
- Fixed income securities are paid in two parts. One part is the payment of interest which happens periodically. Theoretically, it can happen any number of times. However, in reality, it happens twice in a year. This is because of the convention in the fixed income markets. These semi-annual payments are often referred to as coupon payments. The second part is the repayment of interest which happens when the debt owed is returned and the fixed income securities are extinguished.
- The currency in which the payments have to be made is often clearly defined in the bond contract. This is because a lot of the bonds are issued by government authorities which have the power to inflate their currency and pay off their debt.
Size of the Fixed Income Markets
The global bond market is massive in size. The total amount of debt securities outstanding in the bond market total to approximately $119 trillion! Since the United States has one of the most well-developed systems of debt, it accounts for close to 40% of all the outstanding debt!
The fact that fixed income securities dwarf the equity markets can be gauged from statistics. In 2020, about $12.2 trillion worth of new fixed income securities were issued in the United States. However, during the same period only $390 billion worth of equity securities were issued in the stock markets.
What has Changed in the Past Years?
As mentioned above, the fixed-income securities markets have gone through a lot of changes in recent years. Some of these changes have been mentioned below:
- Dynamic Interest Rates: Firstly, governments all over the world now have the power to regulate the power of their currencies. They do so by deciding the interest rates which in turn impacts the real return being provided by fixed income securities. Changing interest rates are the number one reason behind the change in the values of the bond markets. This is the reason that changing interest rates often trigger sharp changes in the bond market.
- Complex Securities: The type of fixed-income securities being traded in the markets has changed drastically over the years. Today, there are many different types of securities that did not even exist a decade ago. For instance, complex asset-backed and mortgage-backed securities which caused the global meltdown in 2008 are a very recent addition to the fixed income market. Newer types of assets mean that the bond market now has the tools to cater to the needs of a variety of investors who have very different risk preferences.
- Fewer Hold to Maturity Investors: Lastly, there are very few investors who buy debt security to actually hold it till maturity. Most of the investors buy securities with the intention of selling them on the liquid market at an opportune time. The rapidly changing real and nominal interest rates mean that it can be very profitable to do so. Hence, bond markets, like the stock markets have become speculative in nature due to the absence of investors who hold the securities to maturity.
The bottom line is that fixed income securities are a huge part of the financial system. It would not be incorrect to say that they are the most prominent financial market in the world. Changes in this market have a huge impact on governments, corporations as well as individuals worldwide.
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- What are Fixed Income Securities?
- Types of Fixed Income Securities
- Types of Coupon Rates in Fixed Income Securities
- Cash Flow Types in Fixed Income Securities
- Bond Indentures and Covenants
- Types of Covenants
- Common Restrictive Covenants in Fixed Income Securities
- Embedded Options in Fixed income Securities
- Zero-Coupon Bonds: Pros and Cons
- Step Up Bonds: Pros and Cons
- Payment in Kind Bonds - Advantages, Disadvantages and its Types
- Treasury Inflation-Protected Securities (TIPS)
- What is Convertible Debt?
- Advantages and Disadvantages of Convertible Debt
- Accounting for Convertible Debt
- Reverse Convertible Bonds
- Advantages and Disadvantages of Reverse Convertible Bonds
- High Yield Bonds
- Advantages and Disadvantages of High Yield Bonds
- Preferred Shares: An Introduction
- Advantages and Disadvantages of Preferred Shares
- Covered Bonds
- Conditional Pass-Through Covered Bond
- Why do Investors Hold Fixed Income Securities?
- What are STRIP Bonds?
- What are Sustainability Bonds?
- Pandemic Bonds
- Municipal Bonds
- What are Eurobonds?
- Yield To Maturity (YTM)
- Yield to Call
- Introduction to Yield Curve
- Inverted Yield Curve
- Bond Duration
- The Calculation of Bond Duration