Types of Fixed Income Securities

When the term “fixed income securities” is mentioned, investors immediately conjure up images of bonds in their heads. However, this is a generalization on the part of the investors.

In reality, fixed income securities can refer to many different types of securities. As an investor, one must be aware of the wide range of securities as well as their pros and cons.

  1. Treasury Bills: Treasury bills are the safest form of fixed income securities in the world.

    In reality, treasury bills refer to the debt securities which are issued by the United States government. However, the term is often used to refer to any kind of debt which has been issued by a government.

    Since governments have control over the money supply of any country, lending to them comes with very little risk. This is the reason why many risk-averse investors park their funds in this asset class.

    Treasury bills are issued for various maturities. This allows investors more options as they can invest according to their liquidity preference.

    It is important to note that treasury bills are important even to investors who are not directly investing in them. This is because these assets are considered to be risk-free. Hence, the interest rate charged by them is considered to be the benchmark rate based on which the interest rate of other securities is also determined.

  2. Bank Fixed Deposits: Bank fixed deposits are the next safest category of fixed income securities.

    Just like treasury bills, the maturity value of the investments is known well in advance to the investors. This is the reason that these investment vehicles are preferred by risk-averse investors. Also, the safety of bank fixed deposits is guaranteed by these big banks.

    For the most part, these banks are quite creditworthy. However, the Lehman Brothers collapse has shown that even the most creditworthy banks can fail. It is important to know that bank fixed deposits are also protected by government guarantees to a certain extent. Hence, in a way, they can be thought of as being sovereign debt. Another important point to note about bank deposits is that these deposits are generally illiquid. This means that investors are supposed to hold them until maturity.

  3. Corporate Bonds: The next category of bonds is corporate bonds. In terms of creditworthiness, corporate bonds rank lower on the ladder as compared to treasury bills and bank fixed deposits. However, the market for corporate bonds is huge. This is because all types of corporations are trying to raise money from the marketplace. This is the reason that investors face a huge choice in this segment.

    They can choose to lend to top-tier blue-chip companies wherein the chance of default is almost negligible. On the other hand, investors could also choose to invest in companies that do not have strong financials.

    There are some investors which specialize in investing money in junk bonds i.e., bonds that are rated below investment grade by credit rating agencies. Corporations have become extremely innovative about the types of bonds that are being issued. There are a wide variety of credit enhancement features as well as many types of coupon rates that are currently being used in the marketplace.

  4. Money Market Instruments: Money market instruments are also used by corporations. However, unlike bonds, these instruments are not long-term in nature. Money market instruments are basically used by companies in order to manage their working capital requirements. However, like other fixed income securities, they too bear a fixed rate of return.

    There are a wide variety of money market instruments such as commercial papers, repurchase agreements, etc. which are commonly traded in the open market. Investors can use these instruments to park their funds or the short term. They are often used in place of bank fixed deposits since they are more liquid.

  5. Asset-Backed Securities: The next category of fixed income securities is called asset-backed securities. These are the wild west of the fixed-income securities market. Over the years, investment bankers have used structured finance to conjure up several different types of securities.

    Some of these securities are backed by mortgages, others by car loans, and yet others by credit card debt. Asset-backed securities are extremely risky. This fact has already been demonstrated in the subprime mortgage crisis.

  6. Annuities: Annuities are different types of fixed-income securities. Normally, fixed income securities return the principal at the end of the tenure. However, when it comes to annuities, the principal is never returned.

    Instead, it is the exchange of a lump sum for a stream of periodic payments. However, since annuities also provide a fixed rate of return, they can be considered to be fixed-income security as well.

Hence, it can be seen that the fixed-income securities market is quite complex. It has many different asset classes which can also be divided into asset sub-classes.

Hence, investors can choose from a wide variety of instruments including risky instruments when they want to make their investment decision.

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