What are the Types Of Fixed Income Securities in India
A rise in savings following the pandemic and low-cost trading has led to an influx of investors. The quick and high returns of the stock market make it appealing to new investors. However, with age, the risk appetite of investors varies. Young investors may be comfortable investing in risky securities, but if you are nearing retirement, you will not want to take risks with your savings.
Additionally, you will want to invest in securities that offer a predictable source of income so you can manage your regular finances or be prepared for emergencies.
Equities may give high returns, but they are risky and volatile investments that depend on market fluctuations. Further, these investments give the best returns in the long term and are not ideal for a regular source of income.
You need an instrument that offers a fixed income at regular intervals, irrespective of market fluctuations. One such popular solution to this is fixed income securities. This article will explain the meaning and types of fixed income securities.
What are Fixed Income Securities?
As the name suggests, fixed income securities provide a fixed income at regular intervals, with a periodic interest payment and principal repayment.
The interest payments are alternatively known as coupons. You calculate the interest on the face value of the security. Since these are fixed payments, the cash flows are predictable and safe from market volatility. However, the returns will be low compared to equities.
Types of Fixed Income Securities
There are different types of fixed-income securities in the market. Here are some of them:
1. Corporate bonds
Companies need capital for financing inventory, upgrading their equipment, or simply expanding. Now, they may issue their shares. However, there is an alternative option, and that is to take out a loan. But, apart from taking loans from banks, they can also issue bonds to the investors. These bonds are known as ‘corporate bonds.’
Under these types of fixed income bonds, the investors purchase the company bonds under the fixed terms and conditions of principal and interest. The maturity tenure can be short, medium, or long-term.
2. ETFs, or Exchange Traded Funds
ETFs, or Exchange Traded Funds, as the name suggests, are funds that trade on the stock exchange. In contrast to investing in one financial instrument, they allow investors to invest in a basket of securities.
Due to the different risk appetites of these investments, diversification is advantageous for investors. You can invest in Debt ETFs to take an exposure to the fixed income securities. These debt ETFs combine the benefits of debt investments with the flexibility of stock investment and the simplicity of mutual funds.
In 2019, the Indian government approved the creation of Bharat Bond Exchange Traded Fund (ETF). This ETF consists of high-quality AAA-rated bonds of public sector companies.
One of the most popular fixed income securities types, debt mutual funds offer relatively stable returns without being exposed to equity market volatility. The funds invest in fixed income generating securities such as treasury bills, short-term plans, commercial papers, government gilt funds, and different duration bonds, among others.
4. Fixed deposits
It is one of the most popular types of fixed income instruments in volatile markets. Fixed deposits(FDs) are issued by banks or non-banking financial institutions (NBFIs) at a predetermined interest rate for a fixed tenure. You will receive the principal and interest amount at the end of maturity.
These rates of interest are locked in at the time of booking the FD. They do not change during the policy tenure, irrespective of market fluctuations.
5. Government bonds
Similar to companies, governments also need to raise capital. Hence, they issue government bonds. Instead of companies, these are issued by state and central government bonds in India.
Government bonds are usually long-term fixed-income securities with tenures ranging from 5 to 40 years. The interest rate on these bonds can be fixed or floating.
6. Commercial paper
Corporate entities sometimes need funds to finance short-term receivables and obligations like payroll, inventories, and new projects. For this, companies issue commercial papers (CPs).
The maturity period of these unsecured money market instruments ranges from seven days to one year. Due to their unsecured nature, RBI has set some guidelines for the issuing entities:
- The tangible net worth of the company should not be more than 4 Crores.
- The issuer should have the ‘sanctioned working capital limit’ by the banks or any Financial Institutions (FIs).
- The ‘Borrowal Account’ should be classified as a Standard asset by banks/financial institutions.
The above article gives a detailed overview of the types of fixed-income securities. Fixed income securities are an ideal option if you are wary of stock market fluctuations and looking for stable investments. Moreover, they play a key role in building a truly diversified portfolio which will protect you from risks.
However, fixed income securities are not completely free from risks. You must consider the interest rate risk, credit risk, and more before investing in them.
What are the risks of corporate bonds?
Corporate bonds are vulnerable to the following risks:
Interest rate risk: The interest rate movements affect the bond prices. As the interest rate rises, the price of the bond falls, and vice-versa.
> Inflation risk: A bond comes with a fixed rate of return for a predetermined tenure. However, during the tenure of the bond, inflation might increase dramatically. This will erode the investor’s purchasing power and the bond’s returns will turn negative.
> Credit risk: It represents the creditworthiness of the issuer. The lower the credit quality, the higher will be the yield.
Who should invest in fixed-income securities?
The following investors should invest in fixed-income securities:
> Those who want a steady flow of income.
> Those whose risk appetite is low.
> Those who are nearing retirement.
> Those whose priority is stable returns.
Are fixed income securities liquid?
Yes, fixed income instruments like fixed deposits and treasury bills are highly liquid.
What does “fixed income” mean in a portfolio?
A portfolio must be a mix of equities and fixed income securities. Equities offer high returns but are prone to high risk due to market fluctuations. The fixed income securities, with their low risk, balance the portfolio.
Are fixed income instruments safe?
Yes. This is because they offer a fixed income irrespective of market volatility. Furthermore, instruments like government bonds and treasury bills are government-backed and, hence, secure. However, they may be prone to interest rate and default risks, as seen in corporate bonds.