Fixed income securities are investment instruments that provide a fixed stream of income to the investor over a specified period of time. These securities are typically issued by governments, municipalities, corporations, and financial institutions to raise capital. They are considered relatively low-risk investments compared to equities, as they offer a predetermined return on investment.
The main types of fixed income securities include:
1. Bonds: Bonds are debt instruments issued by governments, municipalities, and corporations to raise capital. They have a fixed maturity date and pay periodic interest payments, known as coupon payments, to the bondholders. Bonds can be further classified into various categories such as government bonds, corporate bonds, municipal bonds, and agency bonds.
2. Treasury Securities: Treasury securities are issued by the government to finance its operations and manage the national debt. They are considered the safest fixed income securities as they are backed by the full faith and credit of the government. Treasury securities include Treasury bills (T-bills), Treasury notes
(T-notes), and Treasury bonds (T-bonds), each with different maturities.
3. Mortgage-Backed Securities (MBS): MBS are created by pooling together a group of mortgages and selling them as a security to investors. The cash flows from the underlying mortgage
loans are used to make interest and principal payments to the MBS holders. MBS can be issued by government-sponsored enterprises (GSEs) such as Fannie Mae
and Freddie Mac
or by private institutions.
4. Asset-Backed Securities (ABS): ABS are securities backed by pools of assets such as auto loans, credit card
receivables, or student loans. These securities offer investors exposure to the cash flows generated by the underlying assets. ABS can be structured in various ways, including collateralized debt obligations (CDOs) and collateralized loan
5. Corporate Bonds: Corporate bonds are issued by corporations to raise capital for various purposes, such as expansion, acquisitions, or debt refinancing. These bonds offer fixed interest payments and have a specified maturity date. Corporate bonds are rated by credit rating agencies based on the issuer's creditworthiness, with higher-rated bonds considered less risky.
6. Municipal Bonds: Municipal bonds, also known as munis, are issued by state and local governments to finance public infrastructure
projects such as schools, highways, and utilities. Munis offer tax advantages to investors, as the interest income is often exempt from federal and sometimes state and local taxes
7. Preferred Stocks: Although not strictly fixed income securities, preferred stocks have characteristics of both equity and debt. Preferred stockholders receive a fixed dividend
payment, similar to bondholders, before common stockholders receive any dividends. However, preferred stockholders do not have voting rights like common stockholders.
8. Certificates of Deposit (CDs): CDs are time deposits offered by banks and other financial institutions. They have a fixed maturity date and pay a fixed interest rate. CDs are insured by the Federal Deposit Insurance Corporation
(FDIC) up to certain limits, making them relatively low-risk investments.
9. Money Market
Instruments: Money market instruments include short-term debt
securities with high credit quality and low default risk
. Examples include Treasury bills, commercial paper, repurchase agreements (repos), and short-term corporate notes. These instruments are often used by investors seeking liquidity and capital preservation.
Understanding the main types of fixed income securities is crucial for investors looking to diversify their portfolios and manage risk. Each type of security has its own characteristics, risk profile, and potential return, allowing investors to tailor their investments based on their financial goals and risk tolerance.