0 20200411110104fixed Income-Chapter 1 PDF

CHAPTER 1 _ CONCEPT OF FIXED INCOME
FIXED INCOME
Fixed income is a type of investment security that pays investors fixed interest payments
until its maturity date. At maturity, investors are repaid the principal amount they had
invested. Government and corporate bonds are the most common types of fixed-income
products. However, there are fixed-income exchange traded funds(ETF’s) and mutual
funds available.
KEY TAKEAWAYS
● Fixed income is a type of security that pays investors fixed interest payments until
its maturity date.
● At maturity, investors are repaid the principal amount they had invested.
● Government and corporate bonds are the most common types of fixed-income
products.
● In the event of a company's bankruptcy, fixed-income investors are paid before
common stockholders.
Fixed-income securities are recommended for conservative investors seeking a

diversified portfolio. The percentage of the portfolio dedicated to fixed income depends
on the investor's investment style. There is also an opportunity to diversify the portfolio
with a mix of fixed-income products and stocks creating a portfolio that might have 50%
in fixed income products and 50% in stocks.
Association of International Wealth Management Of India (AIWMI), Regus, Platina, Block G, Plot C-59,
Bandra-Kurla Complex, Mumbai-400051 Ph : +91 8097661200 Website: www.aiwmindia.com
Treasury bonds and bills, municipal bonds, corporate bonds, and certificates of deposit
(CDs) are all examples of fixed-income products. Bonds trade over-the-counter (OTC) on
the bond market and secondary market.
Types of Fixed Income Products
● Treasury bills (T-bill) are short-term fixed-income securities that mature within
one year that do not pay coupon returns. Investors buy the bill at a price less than
its face value and investors earn that difference at the maturity
● The Treasury bond (T-bond) is very similar to the T-note except that it matures in
30 years.
● Corporate bonds come in various types, and the price and interest rate offered
largely depends on the company’s financial stability and its creditworthiness.
Bonds with higher credit ratings typically pay lower coupon rates.
● A certificate of deposit (CD) is a fixed income vehicle offered by financial

institutions with maturities of less than five years. The rate is higher than a typical
saving account, and CDs carry FDIC or National Credit Union Administration
(NCUA) protection.
● Asset-allocation or fixed income ETFs works much like a mutual fund. These
funds target specific credit ratings, durations, or other factors. ETFs also carry a
professional management expense.
Advantages of Fixed Income
● Steady income stream

● More stable returns than stocks
● Higher claim to the assets in bankruptcies
● Government and FDIC backing on some
Disadvantages of Fixed Income
● Returns are lower than other investments

● Credit and default risk exposure
● Susceptible to interest rate risk
● Sensitive to Inflationary risk
BONDS
● A bond is essentially a loan that an investor makes to the bonds’ issuer. Issuers can
be:
– Federal government (as in the case of Treasury bonds)
– Local government (municipal bonds issued by states or towns)
– Government-sponsored enterprises (like Fannie Mae)
– Companies (corporate bonds, both domestic and international)
● A bond Issuer offers investors a rate of return in exchange for their initial
investment.
● Bond investors compare the potential for gain with the risk that the issuers will not
pay them back at the level described in the bond’s terms of contract.
KEY TERMS FOR FAMILARIZING ONESELF WITH FIXED INCOME AND

BONDS
Coupon:
The interest rate a bond's issuer promises to pay to the bondholder until maturity, or other
redemption event. It is expressed as an annual percentage of the bond's face value.
Example: A bond with a 5% coupon will pay $50 per $1000 of the bond's face value, per
year.
[Note: An exception is a zero-coupon bond bought at a discount and pays principal at
maturity. which has no coupon, is generally bought at a discount and pays principal at
maturity.]
Maturity:
The date on which the principal amount of a fixed-income security is scheduled to

become due and payable, typically along with any final coupon payment.
Price:
Bond investors have two key price concepts to consider:
● Market Price: The currently quoted bond price. There will be a price that the buyer
can purchase at – “Ask Price”, and usually a price at which they can sell at – “Bid
Price”.
● Par Value: The stated value of a bond-typically $1,000, also known as face value.
Bonds are usually issued and mature at par (i.e.: at maturity the bond holder
receives $1,000).
Bond prices are quoted as a percentage of par:
• The par value of $1000 is quoted as “100.00”. Market prices vary around that so a bond
with an Ask Price of “99.00” is asking the investor to pay:
99% of $1,000 = $990”.
Example:
•You buy 20 bonds. The face value is $20,000. At three points in time,
the market price changes from 97, to 95, to 102.
• In Dollar terms the bonds are valued at

97%* $20K = $19,400; 95% * $20K = $19,000; etc.
Yield:
The anticipated return on an investment, expressed as an annual percentage.It takes into

account the purchase price, the anticipated coupons or cash flows over its life, and the
return of principal when the bond matures or is redeemed
Example: A 3% yield means the investment averages a 3% return each year.
[NOTE:A bond’s yield is inversely related to its price as the price moves up, the quoted
yield of the bond moves down.]
Closer look at Yield: Par bond cash flow
Purchase a 3-year bond at par ($1,000) with an annualised coupon of 5.2%.
● Coupon is paid semi-annually.

● Annual cash flow = $1,000 X Coupon 5.2% = $52.
● Coupon payment = $52 / 2 = $26.
● After 3 years, the bond matures and you receive $1,000 principal with the final
coupon.
● The Yield would also be 5.2%, assuming you hold the bond over the three- year
period and receive all the coupons.
Credit Risk:
● Refers to the possibility that the issuing company or government entity will default
and be unable to pay back investors’ principal or make interest payments.
● When an issuer defaults investors do not receive their expected yield.
● A bond’s degree of credit risk is summarised in “credit ratings” assigned by
agencies such as Moody’s and S&P.
Duration:
Duration measures how sensitive a bond’s price is to changes in the level of market
interest rates.
Example:
• If interest rates were to rise 1%, a bond with a 5-year average duration would
likely loose approximately 5% of its value.
● If the duration of a bond was 10 then the same 1% rise in interest rates would cause
it to lose approximately 10% of its value
BOND MUTUAL FUNDS
Bond mutual funds:
● Invest your money into a pool with other investors.
● A professional invests that pool of money according to what he or she thinks the
best opportunities are and in accordance with the fund’s stated investment goals.
● Easier way to achieve diversification even with a small investment.
● Income payments are made monthly, and reflect the mix of all the different bonds
in the fund and the payment schedule of each.
● The distribution may vary from month to month.
● Unlike a bond, most bond mutual funds do not mature.
KEY TERMS IN BOND MUTUAL FUNDS
NetAssetValue(NAV)
● Represents a fund's per share market value. The NAV plus any applicable sales
charge is the price at which investors buy fund shares from a fund company and
sell them ("redemption price") to a fund company.
● An NAV computation is undertaken once at the end of each trading day based on
the closing market prices of the portfolio's securities.
● NAV is derived by dividing the total value of all the cash and securities in a fund's
portfolio, less any liabilities, by the number of shares outstanding.
Total Expense Ratio (TER)
The total expense ratio (TER) is a measure of the total costs associated with managing an
operating investment fund such as a mutual fund. These costs consist primarily of
management fees and additional expenses, such as trading fees, legal fees, auditor fees,
and other operational expenses.
The total cost of the fund is divided by the fund's total assets to arrive at a percentage
amount, which represents the TER. TER is also known as the 'net expense ratio'
Junk Bond
Junk bonds are bonds that carry a higher risk of default than most bonds issued by
corporations and governments. A bond is a debt or promises to pay investors interest
payments and the return of invested principal in exchange for buying the bond. Junk
bonds represent bonds issued by companies that are struggling financially and have a
high risk of defaulting or not paying their interest payments or repaying the principal to
investors.
Multi-Asset Class
A multi-asset class, also known as a multiple-asset class or multi-asset fund, is a

combination of asset classes (such as cash, equity or bonds) used as an investment. A
multi-asset class investment contains more than one asset class, thus creating a group or
portfolio of assets. The weights and types of classes vary according to the individual
investor.
Market capitalization
With investment securities market capitalization (or market cap), refers to the price of a
share of stock multiplied by the number of shares outstanding. Many quite mutual funds
are categorized based on the average market capitalization of the stocks that the mutual
funds own. This is important because investors need to be sure of what they are buying.
● Large-cap Stock Funds-These invest in stocks of corporations with large market

capitalization, typically higher than $10 billion. These companies are so large that
you have probably heard of them or you may even purchase goods or services from
them on a regular basis. Some large-cap stock names include Wal-Mart, Exxon,
GE, Pfizer, Bank of America, Apple and Microsoft.
● Mid-cap Stock Funds- These invest in stocks of corporations of mid-size

capitalization, typically between $2 billion and $10 billion. Many of the names of
the corporations you may recognise , such as Harley Davidson and Netflix, but
others you may not know, such as SanDisk Corporation or Life Technologies Corp.
● Small-cap Stock Funds- These invest in stocks of corporations of small-size

capitalization, typically between $500 million and $2 billion. While a billion-dollar
corporation may seem large to you, it's relatively small compared to the Wal-Marts
and Exons of the world. A subset of small-cap stocks is "Micro-cap," which
represents mutual funds investing in corporations with average market
capitalization usually less than $750 million.
HOW DO BONDS DIFFER FROM BOND MUTUAL FUNDS
INDIVIDUAL BOND MUTUAL

BONDS FUNDS
Management Investor Professional

Management
Maturity Date Defined maturity Never matures*

dates
Income Defined Variable

Payments coupons distributions
Liquidity Market-depende Fund liquidity

nt
Diversification Portfolio of Typically bond

bonds needed funds invest in
many individual
bonds
Credit Risk Issuer Dependent upon
Dependent underlying
holdings
Cost One-time Ongoing

commission or management
markup fee and other
potential costs
Duration Unique to the Average of the

individual bond fund’s holdings
durations

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CHAPTER 1 _ CONCEPT OF FIXED INCOME

Fixed-income securities are recommended for conservative investors seeking a

Types of Fixed Income Products

● A certificate of deposit (CD) is a fixed income vehicle offered by financial

Advantages of Fixed Income

● Steady income stream

Disadvantages of Fixed Income

● Returns are lower than other investments

KEY TERMS FOR FAMILARIZING ONESELF WITH FIXED INCOME AND

The date on which the principal amount of a fixed-income security is scheduled to

Bond investors have two key price concepts to consider:

Bond prices are quoted as a percentage of par:

• In Dollar terms the bonds are valued at

The anticipated return on an investment, expressed as an annual percentage.It takes into

Example​: A 3% yield means the investment averages a 3% return each year.

Purchase a 3-year bond at par ($1,000) with an annualised coupon of 5.2%.

● Coupon is paid semi-annually.

BOND MUTUAL FUNDS

Bond mutual funds:

● Invest your money into a pool with other investors.

● The distribution may vary from month to month.

● Unlike a bond, most bond mutual funds do not mature.

KEY TERMS IN BOND MUTUAL FUNDS

Total Expense Ratio (TER)

A multi-asset class, also known as a multiple-asset class or multi-asset fund, is a

● Large-cap Stock Funds​-These invest in stocks of corporations with large market

● Mid-cap Stock Funds​- These invest in stocks of corporations of mid-size

● Small-cap Stock Funds​- These invest in stocks of corporations of small-size

INDIVIDUAL BOND MUTUAL

Management Investor Professional

Maturity Date Defined maturity Never matures*

Income Defined Variable

Liquidity Market-depende Fund liquidity

Diversification Portfolio of Typically bond

Cost One-time Ongoing

Duration Unique to the Average of the

You might also like

Example: A 3% yield means the investment averages a 3% return each year.

● Large-cap Stock Funds-These invest in stocks of corporations with large market

● Mid-cap Stock Funds- These invest in stocks of corporations of mid-size

● Small-cap Stock Funds- These invest in stocks of corporations of small-size