Classification of Fixed Income Securities Based on Currencies
A fixed-income security is a type of investment which provides returns in the form of interest and the principal amount at maturity.
Classification of Fixed Income Securities Based on Currencies:
- Foreign Currency-Denominated Bonds: These bonds are issued by Indian Corporations in foreign jurisdictions and are denominated in a freely convertible foreign currency of that jurisdiction. For instance, corporations in India primarily issue bonds in US dollar denominations to raise cheaper funds from the international markets. But this kind of bond has foreign currency risk as any devaluation of the domestic currency would directly increase the issuer’s cost as its repayment would be made by acquiring foreign currency from the market at a higher exchange rate. Typically, these bonds are named after the country or the currency in which the bond is issued. For example, Yankee bonds, Samurai bonds etc. A Yankee bond is a US dollar-denominated bond issued in the USA by a Non-US issuer. In contrast, a Samurai bond is a yen-denominated bond issued by Japan by a non-Japanese issuer.
- Rupee-Denominated Bonds (commonly known as “Masala Bonds”): Masala bonds are also issued in foreign jurisdictions, however, unlike foreign currency denominated bonds, these bonds are denominated in Indian Rupees, hence, exposing the investor to foreign exchange risk. Masala Bonds were first introduced by the International Finance Corporation (IFC) in the year 2014 for the purpose of funding infrastructure projects.
Benefits of Investing in Fixed income Securities:
- Stable Returns: One of the benefits of investing in fixed-income security is fixed returns. Also, it makes an alternative to a savings bank account or a fixed deposit.
- Safe investment option: Fixed income security comes with less risk than other investment options such as equity. The government backs many fixed-income securities; there are almost zero chances of defaulting the payment. Moreover, these instruments are highly rated by credit rating agencies in the market like CRISIL, which minimizes an investor’s risk.
- Diversification: Fixed-income securities offer diversification of the portfolio. We all know that equities deliver much higher returns than fixed-income securities. However, they are volatile and can be risky. To make your portfolio stable, it is essential to invest in fixed-income securities.
- Priority during Liquidation: If the company files bankruptcy and goes for liquidation, the company is liable to pay back its debtors and stockholders. But the company might need more assets to pay off both. In such cases, the lenders of the company, i.e. the bondholders, get priority over equity investors, which is why they are considered a safe investment.
Disadvantages of Investing in Fixed Income Securities:
- Credit Risk: When the bond issuer fails to repay the face value or affects the credibility of the bond issuer, there is a risk of capital loss when the bond issuer fails to pay back the principal or interest. These risks are always associated, so investing in a company with good credibility and a higher credit rating is recommended.
- Risk of Reinvestment: High coupon rates have high reinvestment risk. It is the probability that you cannot reinvest the coupon payment from a bond at a rate akin to the prevailing return.
Choosing the right investment option can be challenging for an individual investor. However, the benefits and disadvantages mentioned above can help you select a suitable investment. In addition, you can safeguard your investments by investing in fixed-income securities.
Frequently Asked Questions
What is the difference between equity and fixed-income securities?
Equity securities invest in equity shares of companies, while fixed-income securities invest in debts, bonds and other related securities. As a result, equity investments include a higher risk and have the potential to provide higher returns, while fixed-income securities include lesser risk but provide fixed returns.
Are fixed-income securities liquid?
Yes. Primarily the fixed income securities are liquid. For example, securities, including Government Bonds, Treasury Bills, Debt Funds, FDs, CDs etc., are considered highly liquid assets.
How do fixed-income securities benefit a portfolio?
Fixed-income securities bring diversification to the portfolio. While equities have the potential to deliver high returns with high risk to the portfolio, fixed-income securities balance the risk with their fixed returns.
Are fixed-income securities safe?
Yes, fixed-income securities are considered safe investments since they invest in instruments that offer fixed income. Moreover, many fixed-income securities are backed by the Government, which mitigates the risk.