Fixed Income Instruments

Fixed income instruments are defined as financial securities generating returns that do not vary according to the performance of those securities. The three main categories of fixed income instruments are fixed-interest bonds, preferred stock, and Treasury bills and notes. While fixed income instruments can vary widely in value depending on current economic conditions, the earnings potential remains constant.

Fixed-interest bonds


One of the most common forms of fixed income instruments, fixed-interest bonds are long-term debt papers with, as their name suggests, a fixed interest rate throughout the life of the bond. This interest rate is generally referred to as a coupon rate; coupon rates may vary at the time of purchase, but remain consistent afterward until full maturity. While some fixed-interest bonds make periodic interest payments to their holders, accrual bonds retain earned interest and compound it, increasing the amount of interest earned when the bond reaches full par value.

Preferred Stock


Preferred stock provides its holder with an equity stake in a company in much the same way that common shares of stock do. Essentially, it demonstrates ownership in a corporation and a priority claim to earnings and liquidated assets. Because preferred stock typically pays a fixed dividend, it is considered a fixed income instrument and provides a consistent, unvarying income stream to preferred stockholders. The fixed dividend amount is expressed as a specific dollar amount or a percentage of the par value of the preferred stock. While preferred shareholders are not generally given voting rights, their claims on any earnings and profits are given priority over common shareholders; their dividends must be paid before any common stock dividends are declared.

Treasury Bills and Notes


Treasury bills, or T-bills, are short-term fixed income instruments. Because they are issued by the United States Treasury Department, they are considered to be low-risk investments. While typical fixed income instruments pay a fixed rate of interest, T-bills do not pay interest in the normal fashion. Instead, investors purchase T-bills at auction, usually at a discount rate that is less than the face value of the security at full maturity. These short-term securities are usually considered bearish, since they assume that the interest rate available will not increase significantly during the year or less that T-bills are held.

The most influential fixed income instrument is certainly the 10-year Treasury note, also known as the T-note. Available on much the same terms as T-bills, the T-note is used to predict economic trends. Because Treasury securities are considered extremely low risk and typically offer lower returns on investment, they are less popular during periods of economic prosperity and optimism. Thus, they typically offer more attractive (lower) discount rates during such periods of expansion and market investment. When the stock market is struggling, however, demand for Treasury securities increases and the discount rate goes up. Analysts use these fluctuations in the price of T-bills and T-notes as indicators of market confidence. When investors believe that they can achieve a better return by purchasing fixed income instruments than risking money on the higher rewards available in the stock market, this is a good indicator of current or impending bear market conditions.
Tim Ord
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