What are Fixed Income Bonds and how do they work?

03/24/2022

A Fixed Income Bond is a financial product with which you as an investor can lend money to an issuing entity. In return, you will be paid interest. This is also known as 'coupon rate'. Simply put, it is a form of borrowing. The buyer of a Fixed Income Bond is by definition a lender. Issuing Fixed Income Bonds is one of the options for companies to fund themselves. This bond must be repaid over time on a pre-agreed date. Until that date, the Fixed Income Bond holder (lender) will receive fixed and periodic coupon payments. The issuing entity of the Fixed Income Bond is a company.

What do you need to know about Fixed Income Bonds?

Some keywords are important to understand regarding Fixed Income Bonds. Three important concepts are: coupon, expiration date and at par.

1. Coupon

The coupon (or coupon rate) is the interest rate paid by the issuing company. For example, if you invest $10,000 in a Fixed Income Bond with an annual coupon of 8.25%, you will be paid $825 per year. The word coupon comes from the days when Fixed Income Bonds actually had a paper coupon that could be converted to the payment.

2. Expiration date

This is the pre-agreed date on which the Fixed Income Bond must be repaid. Typically, these Fixed Income Bonds are viewed as low-risk products. The coupon payments and expiration dates are fixed in advance, making it a stable and predictable source of income. The only exceptions to this are when the Fixed Income Bond is not held until maturity, or when the issuer extends the term of the Fixed Income Bond following a corporate reorganisation.

3. A par

The face value is 'a par' if it is equal to the current price. The nominal rate is the amount paid to the investor at maturity. Will the interest rate rise more than that of the Fixed Income Bond? Then it trades below par. The current price is then below the nominal value. When the face value is below the current price, it trades at a premium. This is called above par. If the share price is equal to that of the Fixed Income Bond, then we talk about 'a par'.

Fixed Income Bonds

The proceeds that companies generate from issuing these Fixed Income Bonds are used to invest so that a company can grow. For example, by issuing Fixed Income Bonds, companies can buy real estate and machinery and carry out profitable projects. The extra income can also be used for research and development or to hire employees. Businesses typically need more money than the average bank can provide. This problem can be solved by giving investors the opportunity to lend money.

How is the price of a Fixed Income Bond determined?

Fixed Income Bonds in which you are invested can also be traded. Despite the fact that the coupon rate and principal are constant, the value can still fluctuate. Several factors influence this value.

First of all, they are counter-cyclical. In times when the stock market is doing well, Fixed Income Bonds are less attractive to investors because other financial instruments such as stocks seem more profitable. This usually causes the value to drop. In this case, issuers must promise higher interest payments to keep them attractive to invest in.

A second factor that determines the price is the interest rate policy. If a central bank keeps interest rates low and is expected to do so over the full term, alternative investment options may look more interesting as prices rise. This can lead to investors selling their Fixed Income Bonds, which lowers the price. As a rule, the value of Fixed Income Bonds rises when the general interest rate falls and vice versa.

Another factor that determines the price is the duration. Fixed Income Bonds with a longer maturity, for example five years, pay more than in the case of a shorter maturity such as one year. The reason is that lenders are paid for investing their money for a longer period of time. Long-term Fixed Income Bonds have a higher coupon rate than short-term variants. Another time element that affects the value is the time to completion. The closer the product gets to maturity, the closer the price approaches face value.

The advantages of Fixed Income bonds

The most obvious advantage is the fact that they are relatively safe. If you hold the Fixed Income Bond until maturity, the face value will be returned.

Fixed Income Bonds are profitable in two ways. First of all because of the regular coupon payments. If you hold the position until maturity, you will receive the face value. Before that date, you will receive interest payments (the coupons). This is also the reason that they are relatively safe. The maturity date and the coupon rate are determined in advance. Second, you can profit by selling your Fixed Income Bond at a higher price than you bought it.

Risks of Fixed Income Bonds

Investing can be rewarding, but it is not without risk. At expatwealthatwork we are open and transparent about the risks associated with investing. Before you start investing, there are a number of factors to consider. It helps to think about the level of risk you are willing to take and what type of products are most likely fit to achieve your goals. All Fixed Income Bonds in which our clients invest have been awarded a positive risk rating by independent rating agencies such as Moody's and Standard & Poor's. Here you can find the Fixed Income Bonds in which our clients are currently investing.

For more information about Fixed Income bonds you can contact us without obligation: info@expatwealthatwork.com