Fixed Income Securities

FIXED INCOME SECURITIES
Prof. Raman Kumar

INTRODUCTION
• Fixed income securities are mainly Debt Securities.
• Debt securities are Public Loans called Bonds.
• Public loans are loans given by investors to companies or
governments.
• These Bonds are divided into several parts with equal value,
called “Par Value” or “Face Value”.
• Bonds can be issued in Domestic Market or Foreign Market.
• Bonds issued in foreign markets are called “Euro-Bonds”.
• When government issues bonds in foreign markets and is
guaranteed by government for interest payment and return
of principal amount it is called “Sovereign Bond”.
Characteristic of Bonds
• Because Bond is Loan Securities it carries with it two
compulsory payments:
• First is, Payment of Interest at a fixed rate till the time of
maturity to the investor.
• Second is, Repayment of Principal amount with or without
premium/ discount at the time of maturity as per terms and
conditions. It is technically called “Redemption of Bond”.
• If maturity time is not fixed at the time of issue of bond, it is
called “Perpetual Bond”.
• If a corporation or government is not able to service the bond,
this is called “Default”. Service of bond mean fulfilling above
given two compulsory payments.
Interest
• Interest is cost of Bond.
• Interest Rate is also called “Coupon Rate”.
• Interest plays a very important role in investment market.
• Hence, Interest rate movement have a direct influence on the
market values of debt securities and an indirect influence on
equity securities. (See your class note for example).
• Thus participants in financial markets try to anticipate interest
rate movements when restructuring their positions.
• Central Bank of the country is a major player of interest rate
movement. When it sees increasing inflation rate, it increases
interest rate at which it gives loan to commercial banks. It does
opposite when inflation is coming down.
BOND VALUATION
• Bonds have different type of value as given below:
• Par Value or Face Value: It is value written on the Bond Certificate. Interest
is calculated on this value.
• Issue Value: It is value at which bond has been sold (issued) to the investor
by the company or government.
• Redemption Value: It is value at which bond will be redeemed at maturity.
• Market value: It is value at which Bond is traded in the bond market.
• Market value is theoretically calculated as present value of future cash flows
associated with bond and discounted at current interest rate. (See your class
note).
• Although, theoretical value of bond is calculated as given above but in real
world value depends on credibility of bond and its demand and availability in
the market (Supply).
• But theoretical value gives a hint to the investor.
Bond Yield
• Yield is annual return on an investment.

• Hence, bond yield is return to investor when he buys bond.
• Yield on bond is dependent on two factors: Purchase Price of
Bond and Interest Received on Bond.
• When price of bond changes in market bond yield changes in
opposite direction.
• Hence Bond Price and Bond Yield are Inversely Related.
• There are two types of Bond Yield:
1. Current Yield, and
2. Yield to Maturity (YTM).
(See your class notes for details)
Bonds Trading
• Bonds have two types of Markets:
• First is Primary Market: It is market where Companies or
Government directly interacts or issues bond to interested buyers.
• Second is Secondary Market: It is market where bonds issued in
primary market are purchased and sold (called traded). For Bonds
secondary market is “Stock Exchange”.
• Two types of bonds are available in the market:
1. Convertible Bonds: These are bonds which can be converted into
Equity Shares if investor accepts after certain time, in full or partly.
2. Non-Convertible Bonds: These are bonds which can not be
converted into Equity Shares.
• In some countries Bond is also called “Debenture”. Hence, both are
same.
Money Market Instruments
• Money market securities or instruments are also mainly fixed
income securities.
• Money market securities are securities whose maturity period
is less than 12 months or less.
• On the other hand Bonds or Debentures are securities whose
maturity period is more than 12 months.
• Money market securities are traded in Money Market not
Stock Exchange.
• Money Market is an Over the Counter (OTC) Market.
• OTC is not a physical market. Traders do trading through
Internet, Telephone, and similar modes.
Risks Associated with Bonds
• There are three types of risk associated with Bond:
1. Credit Risk:
- It is also called Default Risk.
- Default risk relates to possibility that Issuer of Bond may not be able to
pay interest and principal.
- Investors have an option to buy credit risk free securities. Treasury
Securities (also called Government Securities) are considered risk free.
- Securities with a higher degree of default risk must offer higher yields to
attract investors.
- Securities with long term maturity period is subject to higher credit risk.
- There are agencies which publish credit rating. MOODY, STANDARD &
POOR, and FLITCH are such agencies.
2. Liquidity Risk:
-Liquidity refers to convertibility of security into cash. It means
how fast a security can be sold and cash realised without loss,
when needed by investor.
-Investors prefer securities that have high liquidity.
-If all other characteristics are equal less liquid security has to
offer higher yield to attract investors.
-Short maturity period and availability of secondary market
provide liquidity to the security.
3. Tax Status:
-Income Tax on Interest of Security reduces real income
from the security.
-Hence, investors are more concerned with ‘after tax
income’ than ‘before tax income’.
-If all characteristic is same, then taxable security must
offer higher after tax yield than tax free security.
• END

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FIXED INCOME SECURITIES

Prof. Raman Kumar

• Yield is annual return on an investment.

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