Classification of Fixed Income Securities Based on underlying Security

Governments and corporations often require  different funding avenues to raise capital from capital markets . The debt instruments are known as fixed-income securities. They can be issued by a government corporation or any other entity to raise debt, 

These instruments are fixed-income securities since they provide pre-determined interest at regular intervals and repay the principal amount when it matures. 

The bond’s principal amount is called its face value, the fixed annual interest rate is called a coupon, and the date when the full principal amount is to be repaid is known as the maturity date. The price at which the bond is sold is known as the price or the value of the bond.

This blog will discuss the classification of fixed-income securities based on the underlying security.

Classification of Fixed Income Securities Based on underlying Security

Every bond is a fungible loan for which the returns depend on the issuer of the bonds. Bonds can be secured or unsecured. These could be junior or senior types, depending on the claim in the company’s assets during liquidation. Bonds with lower claims priority offer better yields to compensate for their risk. Bonds can also be secured against a particular asset of its issuer. That is why the investor must know the priority in claims of the security they intend to invest in, depending on their risk appetite. 

1. Secured Debt: A bond backed by some sort of assets is known as a ‘secured bond’. The asset backing in secured bonds could be physical assets such as property, machinery or plants or in an intangible form such as stock. For example, the Government issues a bond for the construction of highways; the future revenue secures the bond it will generate through toll collection. If the issuing company defaults, the amount can be recovered by liquidating the collateral. 

2. Unsecured Debt: These bonds are not backed by any asset, and investors invest in unsecured bonds based on the company’s reputation in the market. In the case of bankruptcy, unsecured bonds are paid out last; hence these bonds are riskier comparatively. For example, unsecured bonds are generally issued as notes, corporate bonds etc.

3. Subordinated Debt: A subordinated bond is a bond which in case of a bond issuer’s bankruptcy is paid after the payment of other higher priority bonds. They are also called junior securities. Subordinated debt examples include high-yield bonds, mezzanine bonds, payment-in-kind notes and vendor notes. It is riskier as compared to unsubordinated bonds as these are listed as long-term liability after unsubordinated debt on the balance sheet. Therefore, the companies pay higher interest in subordinated bonds, to compensate for the risk.

4. Credit Enhanced Bonds: It is a strategy to tell the investors that the company would be able to pay back the borrowed money and that there is some guarantee system that supports the borrowing. This strategy helps the bond issuer to improve the creditworthiness of its debt offering. Through credit enhancement, the bondholder is assured that the bond issuer will meet its repayment with additional collateral, insurance or any third-party guarantee. As a result, credit enhancement bonds allow a company to lower its borrowing cost, leading to better rating grades for the bond and mitigating the risk for the investors. For example, if a particular bond is rated BBB, credit enhancement, which ensures repayment by another entity, can improve its rating to upto three notch. In this way, the investors can get an additional source of guarantee for the bonds.

Who should invest in Fixed Income Securities?

Fixed-income securities are one of the most predictable investment options because they provide fixed interest at regular intervals and are ideal for conservative investors with less risk appetite.  Also, individuals who worry about the fluctuations in the stock market and looking for a stable investment option may opt for mutual funds that invest in fixed-income securities. 

It can also be selected by an investor looking to diversify their portfolio, as these schemes ensure a stable flow of interest even when the market is going down. 

Retired individuals can also invest in such securities while looking for security options. Most fixed-income securities fulfil their requirements for low-risk and stable returns.

However, fixed-income securities may reduce the actual value of money since no adjustments are made against inflation, and market advantage cannot be gained in case of a hike in the average interest rates of the stock market. 

Frequently Asked Questions (FAQs)

Are Bonds considered as fixed income securities?

Bonds are the most popular fixed-income security that governments and corporations can issue. Also, there are other money market instruments available for the investor, 

What are some examples of fixed-income security?

Some examples of fixed-income security include Treasury Bonds and bills, corporate bonds, certificates of deposits (CDs) and municipal bonds. 

Who should invest in fixed-income securities in 2023?

For investors who seek constant returns from the investment with low to moderate  risk appetite or senior citizens who cannot monitor markets regularly, fixed-income securities are ideal for them.