Fixed Income Instruments: Explained

Introduction

It is good to get a high return on any investment. But on the other hand higher return investments consist of higher risk. The risk is about whether the borrower will repay the promised amount. Ideal investment is high return with lower risk at the shorter period of time. To compile both the factors fixed income instruments are introduced.

Definition:

Fixed income instrument is an instrument which enables one to get repaid in a fixed time period with promised amount on the amount lent to a borrower. It is basically an agreement form to get paid in a timely manner on the money invested in any investment. It is also known as fixed income securities. The amount of money will be repaid in a promised rate of interest after some certain time span.

Types of Fixed Income Instruments: 

Fixed income instruments are offered by various entities. These are government, bank or financial institutes & corporate sectors.

1. Treasury Bills (T- bills):

  • Treasury bills are short term money market instruments issued by the governments. These are issued to meet short term requirements of the governments. A discount is offered on face value of bill on the time of purchasing & the investor gets repaid at face value at the time of maturity. For example a treasury bill is of 100 INR. The investor gets it 20% discount i.e. 80 INR. & on maturity he gets repaid amount of 100 INR. On the basis of time of maturity T-bills have 3 different parts.

  • T-bills are available in the multiples of Rs. 25000 with the minimum of Rs. 25000.
  • T-bills are issued by RBI as primary market & institutional investment on the secondary market.

2. Government Securities (G-securities):

  • A tradable sovereign security offered by governments i.e. central & state is Government Security. It is a debt pledge done by the government for its expenditures for long time period. It can be extended up to 30 years.
  • Various types of G-securities can be found. These are
  • Few other G-securities are there in the market. They are Call Option securities, Capital Indexed securities, State Development loans & so on. 

3. Certificates of Deposit:

  • A certificate of Deposit (CD) is an acceptance paper issued by bank or financial institutions (FIs) on deposit of money with them. It is a tradable financial instrument issued to pay at a fixed rate of interest at the end of maturity period. It cannot be terminated without any penalties before maturity. 
  • Depending upon the issue CDs have maturity period of 7 days to 3 years. 7 days to 1 year for banks & 1 year to 3 years for FIs. 
  • Interests offered on CDs are compounded monthly, quarterly & yearly. 
  • The amount of investment varies in multiple of lakh starting from Rs. 1 lakh. 

4. Commercial Papers:

  • A bill of acknowledgement issued by corporate sectors of borrowing from the public is known as Commercial Papers (CPs). For current or short term requirements companies raise funds providing CPs. RBI has a set of rules for issuers of CPs 
  • CPs are not tradable. 
  • Maturity period is 15 days to 1 year. 
  • Investment should be minimum of Rs. 5 lakh. 
  • CPs have high return with short maturity period. 

5. Bonds:

  • Bond is an acknowledgement certificate issued by any corporate sector to raise funds from the money market to a lender. The rate of interest & time of maturity is fixed and mentioned in it. 
  • Bonds have both “call” & “conversion” options. Some of them can also be redeemed even before the maturity period i.e. call option and some of them can only be redeemed after the maturity period, i.e. conversion option. 
  • The maturity period is generally 5 to 7 years.
  • 3 types of bonds can be seen generally.

Advantages:


  • Fixed income instruments are more stable than any other instruments. 
  • Provides high return at the time of maturity than other instruments. 
  • Predictable & less risky investment. 

Disadvantages:

  • Fixed income instruments soak the liquidity from the investor & leave fewer options to gain again before maturity. 
  • Very much market sensitive.

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