Fixed Income

Securities -
Introduction
Asset Class
There are four broad asset classes in the market:
1. EQUITY - Investments in stocks or shares comprise the equity asset
class
2. REAL ESTATE - Investments in land or property fall into the real
estate asset class and are long term inflexible investments.
3. COMMODITY - Investments into physical assets such as precious
metals.
4. FIXED INCOME - Fixed income securities denote debt of the issuer,
i.e., they are an acknowledgment or promissory note of money
received by the issuer from the investor.
Introduction – Fixed Income
Securities (FIS)
1. What is Fixed Income Securities (FIS)?
2. What are the features of FIS?
3. What are the benefits of FIS?
4. What are the disadvantages of FIS?
5. Why should you invest in FIS?
6. What are various types of FIS?
7. What are the risks of investing in FIS?
8. Who are the issuers of FIS?
9. Who are the investors in FIS?
What is Fixed Income Securities?
• Fixed Income Securities, commonly referred as bonds, are financial
assets in the hands of the investors that offer a fixed and assured rate
of return.
• Fixed Income, as the name suggests, is an investment avenue wherein
the investor gets predictable returns at set intervals of time. This
investment class is relatively safe with low volatility and forms an
ideal investment option for people looking at fixed returns with low
default risk, e.g., retired individuals.
What are the features of FIS?
The following are the key features of fixed income instruments –
1. Fixed income instruments generate regular or fixed returns through
interest payments.
2. These instruments involve lower risk. Hence they are ideal for investors
with a low-risk tolerance level.
3. The predictability of returns makes fixed income instruments safer than
equity because of the rate of interest and payment structure, which the
investors know in advance.
4. They offer higher rates of interest in comparison to saving accounts.
5. Instruments such as PPF, 5-year Fixed Deposits, and Post Office Deposits
are exempt from tax under Section 80C of the Income Tax Act,1961.
6. Interest earned from FIS are subject to income tax.
What are the benefits of FIS?
1. Consistent returns: Returns from fixed income securities are pre-
determined. Thus, they offer consistent returns. Moreover, the risk of return
fluctuations is minimal due to the lower variance than other instruments.
2. Relatively low risk: Since many of these securities are backed by the
government, large banks, and corporates, they carry a relatively low risk.
However, you should always do your due diligence and check the entity’s
profile before investing.
3. Diversification of portfolio: As discussed earlier, it has been seen that
there has been an inverse relationship between the returns from fixed
income securities and other equity instruments.
4. Higher priority of being paid out in case of bankruptcy: In case the issuer
goes bankrupt, the investors in fixed income securities get a priority in being
paid back before the other stakeholders.
What are the disadvantages of FIS?

1. Low liquidity: investors‟ money is locked for full maturity period

1. Investors have different needs, risk appetites, and financial goals. Those
looking for secure returns without tracking market fluctuations,
irrespective of the earning potential, should invest in fixed-income
securities.
2. People creating a corpus for a child’s higher education or a family
member’s wedding will be most inclined to take minimal risks with their
investment. Fixed-income securities will be a suitable instrument for them.
3. People nearing retirement must create a source of regular income even
when they stop working.
4. For investors with a higher risk appetite, fixed-income securities are an
option to diversify their portfolios.
What are the various types of FIS?
Fixed Deposits
One of the secure fixed-income investment options is a fixed deposit.
Fixed deposits provide excellent investment tenure flexibility. The
returns on fixed deposits are higher than in a savings account. Both
short-term and long-term fixed deposit accounts are available. The
money is secured, however, there is a penalty if it is withdrawn before
the maturity time.
Government Securities
State and central governments issue these fixed-income bonds which are
known as government securities. Since the government issued the bonds,
the risk is lower. Government Bonds are securities backed and issued by the
Government of India through RBI and are of multiple tenors. It is a risk-free
fixed-income investment option with negligible credit risk associated. They
can be easily traded in the secondary market which makes them fairly liquid.
Government Securities commonly known as G-Secs, are debt instruments
issued by the central or state government to finance its fiscal needs. There
are two types of G-Secs; short-term, called treasury bills, having original
maturities of less than one year, and long-term, called government bonds or
dated securities having an original maturity of one year or more.
Corporate Bonds
A corporation uses a corporate bond to raise capital from investors for a
set period of time at a set interest rate. Companies raise funds for
growth and expansion by issuing fixed-income bonds. The risk of
a corporate bond is influenced by the issuer’s creditworthiness, the
company’s financial stability, the company’s ability to repay the debt,
future profitability, and revenues of the company. It is one of the
excellent types of fixed-income security as it provides superior return
opportunities than FDs and Government securities.
PSU Bonds
PSU bonds, which have extremely low default risk, were issued by
government-backed businesses. PSU bonds are the bonds in which the
government is holding generally has more than 51% of its shareholding.
PSU banks, power sector companies, railways, and other government-
owned entities issue these fixed-income bonds. They are considered
safe fixed-income options as government entities (central or state)
issue PSU Bonds.
Money Market Instruments
These include Treasury bills, commercial paper, certificates of deposits,
etc. Money market instruments are short-term financing instruments
ranging from three months to one year. T-Bills are issued by the
government of India through RBI. Money market instruments are an
ideal fixed-income option for investors with a minimum risk profile.
Public Provident Fund
PPF is a fixed-income investment option with minimal risk that offers
better returns than standard savings plans. The money invested is tax
deductible, and the interest earned and the total amount accumulated
are tax-free when withdrawn. However, the investment duration if for
15 years with an option of extending.
What are the risks of investing in
FIS?
1. Default risk: Fixed income securities are ultimately an investment in debt or a
portfolio of debts. They face the risk of the borrower defaulting on the loan. One
can manage this risk by investing in higher credit-rated securities
2. Interest rate risk: Changes in interest rates affect the bond prices, and
consequently the returns from debt mutual funds. If the interest rates rise, bond
prices fall and vice versa. This is known as interest rate risk.
3. Inflation risk: Many fixed-income investment options are long-term securities
with a fixed return. Consequently, persistent inflation could erode their actual
recovery.
4. Reinvestment Risk- This risk entails the possibility that you won’t be able to
reinvest cash flows from a particular investment at a rate similar to the current
return. Such a situation leads to an opportunity cost for the investor.
Who are the issuers?
1. Government
2. Government Agencies
3. State Governments
4. Companies
5. Municipalities
6. Banks and Other Financial Institutions
Who are the investors?
Large institutions such as
• Pension funds,
• Insurance companies,
• Commercial banks,
• Corporations,
• mutual funds, and
• central banks
• Smaller institutions
• Individual investors
Bonds and Money Market
Instruments
Bonds
1. Define Bonds.
2. What are the features of Bonds?
3. What are the advantages and disadvantages of bonds?
4. Discuss different categories and types of bonds
5. How to invest in bonds in India?
6. What is credit rating agency and state its importance?
7. Discuss the benefits of credit rating agencies to investors
8. Short notes on G – Sec, Treasury Bill, Certificate of Deposit (CD) and
Commercial Papers (CP)
Define Bonds
A Bond is a loan to the issuer who pledges to return your investment with
interest. Mostly companies, state or central governments raise funds through
bonds for financing business expenditure and developmental projects.
A bond is an investment instrument that can be classified as a fixed income
asset.
The issuers of the bonds are borrowers and as bondholders, you, as an
investor, become the creditors to the issuing authority.
Bond is a fixed-income instrument that represents a loan from an investor
to a borrower. It is a contract between the investor and the borrower,
where the borrower uses the money to fund its operation and the investors
receive interest on the investment.
What are the features of Bonds?

A. Interest Rate (Coupon): The interest rate is the coupon the bond issuer pays the bondholder. Typically, it is a
fixed percentage of the face value of the bond and is paid out periodically over the bond’s life.
B. Maturity date: The maturity date refers to the redemption date, and the bond issuer must repay the bond's
principal amount to the bondholder. It is the date on which the bond "matures."
C. Face value: The face value is the amount the bond issuer will pay the bondholder at maturity. It is also known
as the par value of the bond.
D. Yield: The yield is the rate of return on a bond. It is a percentage of the bond's current market price. It
considers both the coupon rate and the bond's current market price.
E. Credit rating: Credit rating agencies assign a bond rating based on the issuer's creditworthiness. This rating
reflects the likelihood that the issuer will default on its bond payments.
F. Liquidity: Bonds can be bought and sold in the secondary market so that investors can sell their bonds before
maturity. The liquidity of a bond refers to the ease with which it can be bought or sold in the secondary market.
What are the advantages and
disadvantages of bonds
A. Advantages
1. Steady income: Bonds typically provide a fixed income source through periodic interest
payments. This feature makes bonds an attractive option for investors seeking regular income.
2. Diversification: Bonds offer an opportunity to diversify an investor's portfolio. They tend to have
a low correlation with other asset classes, such as equities and can help reduce overall portfolio risk.
3. Lower risk: They are less risky than equities since they have a higher priority of payment if the
issuer defaults. Bondholders are also typically paid back before equity holders are in liquidation.
4. Predictability: Bonds have a fixed term and interest rate, making them predictable investments.
This predictability can be especially attractive for investors seeking a stable, low-risk investment.
5. Issuer flexibility: They can be issued in various forms and terms, allowing issuers flexibility in
raising capital. Bonds are customized and meet the specific needs of the issuer, such as funding long-
term projects or managing short-term cash needs.
What are the advantages and
disadvantages of bonds
B. Disadvantages
1. Interest rate risk: Generally, bond prices tend to fall when the interest rate increases. It means
that if an investor needs to sell their bond before maturity, they may have to sell at a loss. This risk
is particularly relevant in a rising interest rate environment.
2. Inflation risk: While bonds provide a steady income stream, inflation can erode the value of
that income over time. It means that investors may end up with less purchasing power.
3. Credit risk: Bonds are only as good as the issuer’s creditworthiness. If the issuer defaults,
bondholders may not receive their entire principal and interest payments. One can mitigate the risk
by investing in bonds with higher credit ratings, but this generally comes at the cost of lower yields.
4. Liquidity risk: Some bonds may be difficult to sell quickly, especially if they do not trade
frequently. It can be a problem for investors who must sell their bonds before maturity.
5. Limited potential for capital appreciation: While some bonds may experience capital
appreciation, the potential for price gains is generally limited. Investors looking for significant capital
appreciation may need to consider other investments.
Discuss different categories and
types of bonds
Different categories of Bonds
• Government Bonds: These are the bonds issued by the Central and the State
Government of India. RBI (Reserve Bank of India) manages and regulates these
bonds. Government bonds generally have a low-interest rate.
• Municipal Bonds: These are issued by municipalities or government bodies. When
compared with Government bonds, these carry comparatively more risks.
• Corporate Bonds: These are bonds that are issued by private companies. The
companies issue both Secured Bonds and Non-Secured Bonds. The companies issue
them to raise capital at a low-interest rate. Certain Corporate Bonds pay higher
yields than Government Bonds.
• Asset-Backed Securities: Asset-Backed Securities are Bonds that are issued by banks
or other financial institutions.
Discuss different categories and
types of bonds
Various Types of Bonds
• Callable Bonds: When a Bond issuer calls out his right to redeem the Bond even before it
reaches its maturity, it is referred to as a Callable Bond. This option is exercised by the
Bond issuer. An issuer can convert a high debt bond into a low debt bond.
• Fixed-rate Bonds: Bonds whose coupon rate remains the same through the course or
tenure of the investment, it is referred to as Fixed-rate Bonds.
• Floating-rate Bonds: Bonds whose coupon rate vary during the tenure of the investment,
then it is referred to as Floating-rate Bonds.
• Zero Coupon Bonds: Zero coupon bonds When the coupon rate is Zero and the Bonds
issuer pays only the principal amount to the investor on maturity. It is called as Zero-
coupon Bonds.
• Puttable Bonds: These are those Bonds where an investor sells their bond and get their
money back before the maturity date, then it is called as Puttable Bonds.
How to invest bonds in India?
• Investors can buy through various channels, including banks, post
offices, online trading platforms, and mutual fund companies. Before
investing, it is essential to research the five types of bonds and their
associated risks and returns.
• Investors should also consider their investment goals, risk tolerance,
and horizon. Bonds offer a steady stream of income and
diversification benefits to a portfolio.
What is Credit Rating and state its
importance?
• A credit rating agency rates the creditworthiness of instruments including corporate
bonds, government bonds, certificates of deposit, and other debt instruments that
have collateral.
• These agencies evaluate the risk of a prospective debtor. This is done by analyzing
qualitative and quantitative information about the debtor and predicting their
ability to repay the debt. In other words, it assesses the risk of default on a debt
that may arise from failure to make the timely payments.
• The credit rating provided by these agencies helps in creating a correlation between
risk and return of an instrument. Hence, they offer investors a tool to measure the
risk of any debt instrument and assess if the returns are worth the risks.
• In the absence of a credit rating system, investors tend to perceive the risk of an
instrument based on the popularity of the organization issuing it.
Discuss the benefits of credit rating agencies to
investors

Investors use credit ratings to make investment decisions. They derive the following benefits from
them:
1. Assistance in decision-making – A quick look at the credit rating of an instrument tells investors
about the risks associated with it. This allows them to choose instruments based on their risk
tolerance and expected returns.
2. Regular reviews of ratings – Credit rating agencies regularly review the ratings to ensure that it is
relevant to the existing condition of the issuer and market. Hence, if an investor has purchased
an instrument with the highest rating but finds it to be downgraded, then he can decide to sell
the instrument to curb his losses.
3. Assurance of safety – An instrument with a high credit rating assures investors of the safety of
their investment and the financial strength of the issuer.
4. Ease of understanding – Credit rating agencies have a standard way of rating instruments.
Hence, investors can easily understand the investment proposal.
5. Saves time & effort – Analyzing an issuing company’s financial strength can take a lot of effort
and time. It requires some financial competence too. However, the credit rating provided by
these professional agencies ensures all the important factors are taken into consideration.
G - Sec
• A government security is a tradable instrument issued by the central government or
the state governments.
• It acknowledges the government’s debt obligation.
• Such securities are short-term (usually called treasury bills, with original maturities of
less than one year) or long-term (usually called government bonds or dated securities
with original maturity of one year or more).
• Government securities carry practically no risk of default, and, hence, are called risk-
free gilt-edged instruments.
• With long maturity periods and static interest rates, government securities are not a
high growth investment option. However, they are sovereign in nature and offer
complete capital protection, making them attractive to investors looking at no risk with
stable income. Institutional investors like debt mutual funds invest heavily in
government securities to hedge their investments in securities of higher risk.
Treasury Bills (T – Bills)
• Treasury bills (T-bills) are money market instruments, i.e., short-term debt
instruments
• They are issued by the Government of India, and are issued in three tenors—
91 days, 182 days, and 364 days.
• The T-bills are zero coupon securities and pay no interest. They are issued at a
discount and are redeemed at face value on maturity.
Features:
1. No default risk
2. Ideal short-term investments which can also be traded in the secondary
market
3. Preferred securities for Liquid or Money Market
Certificate of Deposit (CD)
• A „Certificate of Deposit‟ or CD is a financial instrument issued by
banks or other financial institutions (FI). CDs are an acknowledgement
of the deposit of funds with a bank or FI. They carry a fixed rate of
interest which will be paid at the end of the specified maturity period.
They are different from a traditional bank deposit as they can be
traded in the secondary market. They also cannot be redeemed when
needed as they have a maturity period attached to them, or they
carry very heavy penalties on early termination.
• CDs issued by banks can have maturity period between 7 days and 1
year, and those issued by FIs can have maturity from one to three
years.
Commercial Papers (CP)
• Commercial Papers (CPs) are issued by companies, Primary Dealers (PDs) and other
Financial Institutions (FIs) as an acknowledgement of borrowing from the public.
CPs allows the companies to raise funds for current or short- term expenses like
inventories
• CPs have a maturity period ranging from 15 days to a maximum of one year, and
they cannot be traded in the secondary market. Interest rates offered on CPs are
generally at par with market interest rates and may be higher depending on the
credit rating assigned to the issuer.
• Like CDs, CPs offer higher returns than G-Secs and T-Bills and have a short term
maturity period. Issues carrying investment grade credit ratings make attractive
investment options, and they are usually preferred by short term debt funds. The
only drawback is lack of liquidity since they cannot be traded on the secondary
markets.