Fixed Income

The most common type of fixed income product is a bond. A bond is a promise to repay a debt on agreed terms at an agreed time. The bond is the result of a contract that governs the repayment terms and the rights of the respective parties. These can be issued by governments and companies.

Fixed income securities carry a variety of risk factors that can impact on their pricing and valuation. Whilst it is possible to obtain diversification benefits from holding a portfolio of bonds, these typically reduce rather than remove entirely the downside risks from holding bonds.

The normal risk factors that will impact bond prices include:

Interest rate risk; changes in interest rates might impact on both the attractiveness of the interest payable and may cause the price of the bond to fall.

Inflation risk; higher inflation erodes the real future value of cash flows and the real value of the bond.

Credit risk; the probability that the Issuer of the bond will not fulfil their obligations to repay both interest and capital when it falls due. The assessment of credit risk is determined by three main rating agencies. Should these rating assessments change due the deterioration in the Issuer’s financial position then the bond price will decline.

Liquidity risks; many fixed income investments are securities that are bought and sold in the marketplace. At times the level of investor interest in these bonds may fluctuate influencing the bonds liquidity Lower liquidity levels make it harder for sellers to acquire bonds and for sellers to liquidate their bonds.

Call risks; sometimes issuers have certain rights in respect of their bonds, For example they may be able to buyback the bonds at a fixed price in the future or convert the bond into shares. The Issuer’s rights will impact the pricing of specific bonds.