Fixed Income Securities

A Relative Safety Investment For Rough Economy

From SmartInMoney
U.S. economic prospects are so grim as shown by recent leading economic indicators. Investors will take shelter in the relative safety of the bond market during a painful economic period. Weaken earnings during the rough economic time will cause price-earnings multiples of stocks collapse triggering stock market sell off.

Companies, municipalities, states, U.S. government, and foreign governments issue bonds, commonly referred to as fixed-income securities, to finance a variety of projects and activities.

Bonds are debt investments in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate. Interest on bonds is usually paid every six months (semi-annually). The annual return rate that the bond will pay is usually referred to as the yield of the bond. The entity returns the investor's principal at the maturity. Before maturity, the value of fixed-income investments can fluctuate in response to current interest and inflation rates.

Bonds are generally a less risky asset than equities (their variance of returns has been lower over time) but produce lower rates of return. Bonds are considered as a distinct asset class commonly used in investment portfolio construction because they have different risk and return characteristics from other asset classes. Some types of bonds include Treasury bonds, municipal bonds, corporate bonds, foreign bonds, asset backed securities, and mortgage backed securities.

Treasury Bonds (T-Bond) A marketable, fixed-interest debt security issued by U.S. government with a maturity of more than 10 years. Treasury bonds make interest payments semi-annually and the income that holders receive is only taxed at the federal level.

Municipal Bonds
Also known as a "muni", this is a debt security issued by a state, municipality or county to finance its capital expenditures. Municipal bonds are exempt from federal taxes and from most state and local taxes, especially if you live in the state in which the bond is issued.

Corporate Bonds
This is a debt security issued by a corporation and sold to investors. The backing for the bond is usually the payment ability of the company, which is typically money to be earned from future operations. In some cases, the company's physical assets may be used as collateral for bonds. Corporate bonds are considered higher risk than government bonds. As a result, interest rates are almost always higher, even for top-flight credit quality companies.

Foreign Bonds
Foreign countries issue bonds in their domestic market in their home currency to fund the operations of the government. Foreign bonds are regulated by the domestic market authorities. The investor is taking on a couple of risks with foreign bonds. First, the bonds are dominated in the foreign country’s currency so there is some currency risk. Secondly, changes in interest rates for that country will impact bond prices.

Asset-Backed Securities (ABS)
There are a host of fixed income securities whose payments are backed by assets. These securities generally will make periodic payments to the owner of the security. There is an asset (like loans, leases, credit card debt, a company's receivables, and royalties) which provides collateral in case there is a non-payment by the party which has entered into the payment arrangement. These securities are often offered by financial institutions which have created the security from a bunch of underlying assets which they have purchased. For investors, asset-backed securities are an alternative to investing in corporate debt.

Mortgage-Backed Securities (MBS)
A type of asset-backed security that is exclusively secured by a mortgage or collection of mortgages. These securities must also be grouped in one of the top two ratings as determined by an accredited credit rating agency, and usually pay periodic payments that are similar to coupon payments. Moreover, the mortgage must have originated from a regulated and authorized financial institution. MBS is also known as a "mortgage-related security" or a "mortgage pass through". When you invest in a mortgage-backed security you are essentially lending money to a home buyer or business. The bank that originated the mortgage acts as a middleman between the home buyer and the investment markets.