Fixed Income Securities: Meaning, Types and Risks

Investors often look for ways to balance growth with stability in their portfolio. Fixed income securities provide a way to generate predictable returns while preserving capital. These instruments are especially favoured by conservative investors, retirees, or those seeking to reduce portfolio volatility. This blog explores what fixed income securities are, how they work, their types, and the risks and benefits associated with them.

What are Fixed Income Securities?

Fixed income securities are investment instruments that offer regular and fixed interest or dividend payments until maturity. At the end of the term, the principal amount is returned to the investor. These instruments are essentially loans given by investors to governments, corporations, or financial institutions in exchange for periodic interest payments.

Common examples include government bonds, corporate bonds, debentures, and fixed deposits. Unlike equities, where returns depend on market performance, fixed income instruments have a predetermined return structure, making them more predictable and less volatile.

How Fixed Income Security Works

When an investor buys a fixed income security, they are effectively lending money to the issuer. In return, the issuer agrees to pay interest at regular intervals (monthly, quarterly, or annually) and repay the face value of the instrument at maturity.

For example: If you purchase a bond worth ₹5,00,000 with a 7% annual interest rate and a 5-year maturity, you will receive ₹35,000 every year, and the full ₹5,00,000 at the end of 5 years. The interest payment is often called a "coupon."

These securities are issued with various tenures, from a few months to several years. Government securities tend to be longer-term and are considered safer, while corporate bonds offer higher interest but carry more risk.

Types of Fixed Income Securities

There are several types of fixed income instruments available to Indian investors:

Government Bonds

Issued by the central or state government to fund public projects. They are considered low-risk and come with fixed interest payments.

Treasury Bills (T-Bills)

Short-term securities issued by the Government of India with maturities of up to one year. They do not carry a coupon but are issued at a discount and redeemed at face value.

• Corporate Bonds and Debentures

Issued by private companies to raise funds. These offer higher returns than government bonds but carry higher credit risk.

• Fixed Deposits (FDs)

Offered by banks and non-banking financial companies (NBFCs), FDs guarantee a fixed return for a fixed period. They are insured up to a certain limit in India.

• Public Sector Undertaking (PSU) Bonds

Issued by government-owned corporations. They combine the relative safety of government backing with better interest rates than traditional savings.

• Municipal Bonds

Issued by urban local bodies to finance infrastructure projects. Although not as common, they are gradually gaining traction in India.

• Provident Fund and Pension Schemes

These are long-term fixed income investments with tax benefits, suitable for retirement planning.

Pros and Cons of Fixed Income Security

Advantages:

• Stable returns: Regular interest payments provide a steady income stream.

• Lower volatility: Prices of fixed income securities are generally less volatile than equities.

• Capital preservation: Ideal for risk-averse investors looking to protect their principal.

• Diversification: Including fixed income instruments reduces overall portfolio risk.

• Tax benefits: Certain government bonds and schemes offer tax exemptions under Indian tax laws.

Disadvantages:

• Lower returns: Compared to equities, fixed income yields may be modest.

• Inflation risk: Returns may not always keep up with inflation, leading to loss of purchasing power.

• Interest rate risk: If interest rates rise, the value of existing bonds may fall.

• Credit risk: Especially relevant for corporate bonds, where the issuer may default on payments.

Risks Associated with Fixed-Income Securities

Investing in fixed income instruments isn't entirely risk-free. Here are some of the key risks:

1. Interest Rate Risk

As market interest rates rise, the prices of existing fixed income securities tend to fall. This is because new securities may offer better returns, making older ones less attractive.

2. Credit Risk

This is the risk that the issuer might default on interest payments or fail to repay the principal. Credit rating agencies help assess this risk, with lower-rated bonds generally offering higher returns to compensate.

3. Inflation Risk

Fixed returns can lose real value over time due to rising inflation. For long-term investors, this erodes purchasing power.

4. Liquidity Risk

Some fixed income instruments, especially those issued by private companies or smaller municipalities, may be hard to sell quickly without impacting the price.

5. Reinvestment Risk

If interest rates decline, investors may be forced to reinvest the interest or principal at lower rates when the securities mature.

Conclusion

Fixed income securities can play an essential role in any well-balanced investment portfolio. While they may not offer the high growth potential of equities, their reliability, regular income, and lower volatility make them valuable, especially in uncertain markets. Indian investors have access to a wide range of fixed income instruments suited to different risk appetites and financial goals. As always, it is important to match the choice of security with your investment horizon, income needs, and risk tolerance.