Fixed income investments
Fixed income investments are fixed income bearing instruments issued by Government, a Corporation, Municipality or Government Sponsored Agencies. They pay interest at specified intervals at predetermined rates and in fixed amounts. These fixed income investments have become a very important part of a well-diversified portfolio of a modern investor. These investments are suited for investors whose risk appetite is very low and who are income oriented.
Reasons for Investing in Fixed Income Investments:
Basically there are 2 primary reasons for investors to invest in and include fixed income investments in their portfolio. They are:
- Regular Income
It gives regular and steady income from investments.
- Diversification
Diversification is very much essential to an individual investor\'s portfolio performance.
Various kinds of Fixed Income Investments:
Certificates of Deposit (CDs) :These are savings instruments issued by banks. Investing in a Certificate of Deposit means that, in effect, lending to the bank a set amount of money that it then invests in securities or loans. The Principal and Interest over the period of the certificate of deposit is guaranteed. One can find CDs with a different maturities and interest payment options. The objective of Certificate of Deposits is to provide regular and guaranteed income over short and intermediate periods of time. It is well suited for low risk and income oriented investors.
Corporate Bonds :Corporate bonds are, as its name suggests, loans given to a Corporation. In corporate bonds also the principal and interest are assured. Interest is payable at a fixed rate on a fixed date. On maturity the corporation returns the principal. Corporate bonds can be issued for a period ranging form one to 40 years. The objective of this product is to provide regular interest income over the life of the bond. These bonds are well-suited for investors seeking regular income and whose risk appetite is very low.
Government-Sponsored Enterprises [Agency Bonds]: These are bonds issued by Government-sponsored enterprises like Fannie Mae, Freddie Mac, Federal Home Loan Bank and by wholly owned government corporations such as the Tennessee Valley Authority (TVA). As in the case of CDs and Corporate bonds Agency bonds also assure interest income over the period of the bond and the repayment of principal on maturity. These bonds come with a period ranging from one to 40 years. The objective of this product is to provide regular interest income over the life of the bond. These bonds are well-suited for safety-conscious, income-oriented investors.
Mortgage-Backed Securities:These are securities backed by a pool of mortgage loans issued by government agencies and private corporations. These are normally sold to brokers and then the brokers resell them to the retail investors. The interest income and repayment of principal are assured.
Municipal Bonds :These are fixed-income bearing bonds issued by villages, cities, counties, states, state agencies or special districts. There are two main types of municipal bonds namely, general obligation and revenue bonds. These are backed by the taxing power of the issuer.
General obligation bonds: These are bonds issued for general needs of an area. A bond issued to build a new school may be a general obligation of the town where the school is located. The interest and repayment of principal to the bond holders will be met out of the property taxes paid by residents of that area.
Revenue bonds: These are bonds issued to solve common problems of an area. A bond issued improve a water system of an area is a revenue bond. The locals using the water system will pay user charges, this will be used to operate and maintain the water system. The interest and repayment of principal to the bond holders will be met out of the revenues earned from the water system.
Objective of municipal bonds are to provide income that is free from federal income tax and, in some cases, state and local income tax. These bonds are well suited for income-oriented investors who also seek tax-free income.
U.S. Treasury Securities:These securities are issued to make up the gap between the government's receipts and expenditures. These securities are the direct obligation of the Government. These are fixed income bearing securities. Interest and Principal repayment are guaranteed by Government. The objective of these bonds is to provide investors with income over a certain period of time. These are well suited to safety-conscious income-oriented investors.
Zero Coupon Bonds:These bonds are backed by the full faith and credit of the United States government. These securities, known as STRIPS, are issued directly by the Treasury. Zero coupon, Treasury-backed bonds, such as CATS and TIGRs are not issued by the Treasury, but they are 100 percent collateralized by U.S. Treasury bonds. These bonds are offered at a deep discount and mature at face value. They compound semiannually at the corresponding yield the investor locks in at the time of purchase. The objective is to provide investors who don't need income now and the opportunity to let their money grow. These are government guaranteed, until a specific future date. Zero coupon treasury bonds can be used for any situation where the goal is to accumulate a specific amount of money by a certain future date. Not suited for income oriented investors. But well suited for low risk investors who looks for capital appreciation.
Insured Corporate Bond Unit Trusts:These bonds are investment in a fixed, diversified group of professionally selected corporate bonds. A unit-holder of this trust will own a portion of every insured corporate bond in the trust. The objective of this bond is to provide its unit-holders a high current income through owning a portion of a diversified portfolio of insured corporate bonds. These are well suited to income-oriented investors seeking a high rate of return.
Municipal Bond Unit Trusts: These bonds are investment in a fixed, diversified group of professionally selected municipal bonds. A unit-holder of this trust will own a portion of every insured municipal bond in the trust. The objective of this bond is to provide short, intermediate or long-term income that is free from federal taxes and, in some cases, state taxes. These bonds are well suited to income-oriented investors seeking tax-free income and diversification.
Taxation of the above bonds:
Certificate of Deposits: The interest income and capital gains from these are subject to federal and state taxes
Corporate Bonds: Interest and capital gains earned from corporate bonds are subject to both federal and state taxes.
Agency Bonds: Interest and capital gains earned is fully federally taxable unless held in a qualified retirement plan. Bonds from some issuers are exempt from state and local income taxes.
Municipal Bonds: The interest earned from municipal bonds is free from federal income tax and, in some cases, state and local tax.
US Treasury Securities: US Treasury securities are exempt from taxes on a state and local level.
Zero Coupon Bonds: Zero coupon treasury bonds are state and local tax-free.
Insured Corporate Bond Unit Trusts: Corporate bond trusts are subject to federal and state taxes.
Municipal Bond Unit Trusts: Interest is exempt from federal taxes, and in some cases, state taxes as well.
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