Classification of Fixed Income Securities based on the Type of Issuer

If you invest in the Indian financial market, you must ensure you maintain a proper balance of your portfolio. Investing into a single asset class is a risky venture. Hence, diversifying investments across assets allows a steady income and avoids dependence on just one asset class. In this case, fixed-income securities play an essential role. In this blog, you will understand fixed-income securities and their classification based on the type of issuer.

What are Fixed Income Securities?

As the name suggests, fixed-income securities give fixed and predictable returns, which is why they are trendy among conservative investors who look for stable returns. Because fixed-income securities generate periodic returns, they constitute a liability for the entity that issues them into the market. As a result, the interest payable on these instruments is constant irrespective of the market conditions. 

The final value of these instruments at the time of maturity is calculated before they are issued. That means investors can know the amount they will get on maturity at the time of investment. 

Classification of Fixed Income Securities based on the Type of Issuer

1. Government Bonds

Central and state governments issue debt instruments to fulfil their needs and manage the money supply. These bonds are issued when the government needs funds for developing infrastructure or fund welfare projects. In exchange, the government pays the investors periodic interest and the principal amount on maturity. These bonds are issued under the Reserve Bank of India (RBI) supervision. These bonds are known as risk-free as the investors get a sovereign guarantee, and the chances of default are rare as the government has the option to print the money to payback the bondholders. At the same time, these instruments pay less interest since they include less risk. In India, Government Bonds have the largest market share in the fixed-income market. Types of government bonds include Treasury Bills, Cash Management Bills, Dated Government Securities, Fixed- Rate Bonds, Floating Rate Bonds, Zero Coupon Bonds, Sovereign Gold Bonds, 7.75% GOI Savings Bond etc.

2. Municipal Bonds: 

They are also known as ‘muni bonds’. It is a debt instrument issued by city corporations and other associated bodies in India. Whenever the local government body needs funds, they issue municipal bonds. These instruments have a fixed maturity period, and investors earn fixed interest rates. Also, short-term bonds are available with a maturity of one to three years, and long-term municipal bonds have a maturity of up to ten years. In addition, these bonds have some tax advantages for investors. For example, governmental entities issue a general obligation bond (GO). It is not backed by revenue from a particular project but by the credit and taxing power of the issuing jurisdiction. Municipal bonds are a safe source of investment because they have specific revenue sources to secure them. The first municipal corporation to raise money through these instruments in Southeast Asia was the Ahmedabad Municipal Corporation, which raised Rs. 100 crores in 1998. 

3. Corporate Bonds: 

Corporations issue this debt security to raise funds for their operations and expansion. They pay principal and interest as per the schedule pre-defined at the time of issue of bonds. Corporate bonds provide a higher rate of interest compared to government bonds, and these bonds are generally short-term investments. Hence investors can reap the benefit within a short period. However, the performance of these bonds depends on the revenue and profitability of the companies that issue these bonds. In addition, corporate bonds are riskier than government bonds because, here, the investors don’t get sovereign guarantees, and the returns depend on the company’s earnings and financial stability. Types of corporate bonds can be Zero- coupon, convertible, floating-rate, fixed-rate, investment-grade and junk corporate bonds.

4. Securitized Debt: 

Securitization is the process of monetizing illiquid loan assets of a lender, including a bank, into a liquid pool of tradable assets. It is achieved by creating a Special Purpose Vehicle (SPV) and structuring the loan pool into tradable bonds. These securities transfer the ownership of assets, including loans and receivables, to the SPV. Types of securitized debt instruments include mortgage-backed securities (MBS), asset-backed securities (ABS) etc. 

Last Words

Although the bond market may appear complex for an investor, a bond is a fixed-income investment that is comparatively less risky than equity. Therefore, bonds are an excellent option to diversify the portfolio and get a stable income. 

Frequently Asked Questions (FAQs):