Fixed income securities are a popular investment among investors who need a regular cash in-flow. A retired person or a widow are examples of individuals who do not want to risk their principal but want a dependable payment to come in regularly to live on. They may also just want to get a stable return on their investment. It is not just individuals who demand fixed-income products, but also organizations such as pension fund companies, university endowment funds, insurance companies, banks and other financial institutions that want these types of securities.
Government bonds are issued by governments in their own currency. These are perceived as risk-free bonds in the financial world because of the ability of the government to increase taxes or print some of their own currency to meet the payments. However, there have been rare instances where governments have defaulted with a very recent example being that of Greece last year.
Sovereign bonds are a type of bond that a government issues in a foreign currency. One of the problems with government bonds are that they are exposed to inflation and currency risk. Inflation-indexed bonds are a solution for this type of risk where the coupon payments increase with an expectation of a rise in inflation, an actual increase in the real inflation rate or both. A municipal bond is something that a local government would issue and is something that the personal finance expert Suze Orman recommends all the time on her show.
Companies also participate in fixed income schemes with their corporate bonds. But in comparison to government bonds they are considered a risky investment and bond holders are compensated for this by being paid out a higher yield than that offered by government bonds.
An issuer of a fixed-income security can be forced into bankruptcy by missing a payment whereas a corporation that misses a dividend payout on a stock that is issued will not be in any threat of default. This gives an owner of a fixed-income security a big advantage when it comes to capital preservation and also the regular payments that an investor is entitled to.
There are still some risks that fixed income investments come with. These risks could range from climate risk to political risk – actions of a government that can endanger the benefits that an investor receives from a security – to the inflationary and currency risk that was mentioned earlier. It is the job of fixed income analysts to study these risks and guide investors and financial institutions properly. However, these risks are fairly limited relative to trading stock.