Fixed Income Bonds, Fixed Income Bond
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Investments that yield fixed-periodic returns and repay the principal on maturity are called fixed income bonds. These bonds are preferred by investors seeking fixed, regular income that could either substitute or add to their earnings.
An example of a fixed income security is a government bond with a 5% interest rate and a ten-year maturity period.Investing $1,000 in this bond would yield $50 annually and $1,000 in the tenth year.
The most common types of fixed income bonds are the ones that are issued by the government. They generally include governmentnotes and bills that have a maturity period of one to ten years. However, fixed income bonds yield a lower return than variable income securities.
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How do Fixed Income Bonds Work?
Fixed income bonds are based on the simple principle of lending money to a borrower and receiving interest payments at regular intervals. The lender receives the principal amount after the loan matures.
The interest rates are generally fixed at the time of bond issuance. Irrespective of the movement of interest rates in the market, a bondholder is assured of the rate on his/her bonds. However, bondholders would be impacted by changes in the market interest rates if they decide to sell their bonds earlier than the maturity date.
Benefits of Fixed Income Bonds
The benefits of fixed income bonds include:
- They provide a predictable income stream.
- Investments are safe.
- Irrespective of market trends and interest rate fluctuations, an investor is aware of the final payment of the fixed-income bond.
Risks Related to Fixed Income Bonds
While buying a fixed income bond, an investor must consider the following risk elements:
- Credit risk: Evaluate the credit worthiness of the issuer to minimize the risk of payment defaults. Federal bonds backed by the US government and government agencies are considered to be the safest.
- Interest rate fluctuations: Interest rate fluctuations alter bond prices. However, this risk is valid for bonds that are sold prior to the maturity date. An increase in interest rates is unfavorable for bond prices and the reverse also holds true. This inverse relationship is an outcome of the issuance of new bonds with a higher interest rate, which affects the attractiveness of existing bonds having a lower interest rate. The longer the maturity period ofthe bonds, the greater will be the impact of the changes on the rate of return.
- Inflation risk: Annual inflation dilutes the actual value of returns. To avoid this, an investor can consider buying US Treasury Inflation-Protected Securities (TIPS). TIPS adjusts the final return against the consumer price index (CPI).