Fixed income investments

Definition

Fixed income investments are financial instruments that provide a return in the form of regular, fixed payments and the eventual return of principal at maturity. These investments are typically associated with bonds, government securities, and other debt instruments, which are considered less risky compared to equities. The consistent cash flow generated from fixed income investments makes them attractive for individuals and institutions looking to balance their portfolios and ensure a reliable source of income.

5 Must Know Facts For Your Next Test

1. Fixed income investments are often seen as a safer alternative to equities because they provide predictable cash flows.
2. The expected return on plan assets heavily relies on the performance of fixed income investments, particularly in pension plans where steady returns are critical.
3. Interest rates play a significant role in determining the value and yield of fixed income investments; when rates rise, bond prices typically fall.
4. Inflation can erode the purchasing power of the fixed payments received from fixed income investments, impacting their real returns.
5. Investors often use fixed income investments to diversify their portfolios and reduce overall volatility while achieving stable returns.

Review Questions

• How do fixed income investments contribute to an investor's portfolio strategy?
  • Fixed income investments play a vital role in an investor's portfolio strategy by providing a stable source of income through regular interest payments. They help diversify overall investment risk since they tend to be less volatile than stocks. Additionally, including fixed income assets can balance out the higher risk associated with equities, particularly during economic downturns when stock prices may decline.
• What factors influence the expected return on plan assets that are heavily invested in fixed income securities?
  • The expected return on plan assets invested in fixed income securities is influenced by several factors, including prevailing interest rates, the credit quality of the underlying bonds, and market conditions. Changes in interest rates directly affect bond yields; as rates rise, existing bonds may decrease in value. Additionally, the creditworthiness of issuers impacts the risk profile of the investments and can alter expected returns based on their perceived likelihood of default.
• Evaluate how fluctuations in interest rates can impact both the value of fixed income investments and overall portfolio performance.
  • Fluctuations in interest rates have a significant impact on the value of fixed income investments. When interest rates increase, existing bonds typically lose value because new bonds are issued at higher rates, making older bonds less attractive. This decrease can lead to capital losses for investors if they need to sell before maturity. In terms of overall portfolio performance, rising interest rates can negatively affect an investor's returns if their portfolio is heavily weighted towards fixed income securities, potentially leading to lower overall returns during periods of rate hikes.

Related terms

Bonds: Bonds are debt securities issued by corporations or governments to raise capital, promising to pay back the principal along with interest at specified intervals.

Yield: Yield refers to the earnings generated and realized on an investment over a specific period, expressed as a percentage of the investment's cost or current market value.

Interest Rate Risk: Interest rate risk is the potential for investment losses due to fluctuations in interest rates, which can affect the value of fixed income investments.