Fixed income securities is a term used to describe securities that have a fixed stream of payments. This is usually referring to bonds where the borrower is promising to pay a fixed interest payment at specified intervals and the principal at the end of a specified period. The opposite category can be called Variable income securities where the return is not promised and is uncertain. Equity stock is an example where the company is not under any legal obligation to pay a dividend or cause an increase in stock price.
Bonds, Bond Valuation & Risk
Courses on fixed income securities are taught in undergraduate and graduate and MBA programs using a number of text books. GraduateTutor.com’s corporate finance tutors provide live online tutoring to students trying to understand Understanding fixed income securities. Understanding Fixed income securities requires you to understand:
- The various properties of bonds: par value/face value, coupon rate, maturity date, bond indenture, etc.
- Types of bonds available (Coupon, Zeros, STRIPS, TIPS, Convertibles)
- Bond ratings
- Cash flows associated with the bond
- Time value of money
- Valuing bonds
- Spot rates & Forward rates
- Returns expected (Yield to maturities, Yield to call, Holding Period Return, etc.)
- Term Structure
- Yield Curve
- Sinking funds
- Interest rate risk
The goal of understanding fixed income securities is to manage your own or your firm’s bond portfolio which hopefully is part of your asset allocation strategy. Bonds are held along with other types of assets for a variety of reasons. Sometimes it is to minimize risk, sometimes it is because of the need of specific amounts of cash at specific times, as a hedge, etc. The proportion of bonds in a portfolio will also vary depending on your risk profile and objectives. For example a young professional may have a lower weight of bonds than a retiree given their time horizon, income levels and immediate cash needs. A pension fund will have more bonds than college endowment fund given the cash flow schedule.
Bond Portfolio Management Strategies
The strategies for managing a bond portfolio will depend on the objectives of the fund. Bond portfolio management strategies can be broken up into two types.
- Passive bond portfolio management strategies; and
- Active bond portfolio management strategies.
Some of the concepts our corporate finance tutors can tutor you on include:
- Interest rate risk (volatility due to changes in market rates)
- Duration (approximate weighted average time to maturity)
- Modified Duration (% change in price of bonds for a given change in market rates or yield to maturity)
- Convexity (the curvature of the bonds price to changes in market rates)
- Portfolio immunization strategy (protecting the portfolio from interest rate risk)
- Re-balancing bond portfolios
Passive Bond Portfolio Management Strategies
Passive bond investment strategies assume that bond prices as set fairly by the market. Instead of trying to beat the market by using insight or analysis, Passive investment strategists seek to simply obtain a fair return for a given level of risk in any market environment.
- Index funds (~ diversification)
- Portfolio immunization strategy (protecting the portfolio from interest rate risk)
- Dedication strategy (cash flow matching)
Active Bond Portfolio Management Strategies
Active bond portfolio investment strategies try to get higher returns than the market by exploiting managers skills, experiences, insight and understanding. Here active bond portfolio management strategists believe that they can get higher returns than the risk level indicates. Active bond portfolio management strategists use two levers to generate higher returns:
- Interest rate forecasting: By anticipating movements in interest rate over time they take positions that enable them to profit before the public react.
- Seeking arbitrage opportunities: Finding mispriced bonds or securities in the fixed income market.
Active bond portfolio management strategies will provide ‘abnormal returns’ only if the strategists insight or position is different of the public and is accurate or in the right direction.
GraduateTutor.com’s corporate finance tutors provide live online tutoring to students using many fixed income text books. Do let us know if GraduateTutor.com’s corporate finance tutors can assist you with live online tutoring to help you understand fixed income securities. We also have a series of articles to help students understand bonds and fixed income portfolios which includes: