The beloved asset class of Brazilians, now in dollar version. Come and discover in this article what fixed income is, how it works in the American market, what are the main ways to access it and much more.
What is fixed income?
Fixed income securities are financial instruments that represent loans granted to governments, companies and other entities. Essentially, when you purchase these bonds, you are lending money and, in return, receive regular interest payments. At the end of the term, the principal amount is repaid.
Unlike stocks, which provide equity ownership in a company, fixed income securities do not provide participation in the business. However, in situations of bankruptcy or default, holders of fixed income securities have priority over shareholders in receiving payments.
These instruments are issued by governments, corporations, and other entities as a way to obtain financing for their operations. Investors choose to acquire fixed income securities aiming for cash flow stability and to diversify their investments, thus complementing their portfolios which may include shares and other asset classes.
How does American fixed income work?
The term “fixed income” refers to the interest payments an investor receives, which depend on the credit strength of the issuer and current interest rates.
In general, fixed income securities, such as bonds, pay a higher interest rate, known as coupon, the longer the term until maturity. This is because issuers agree to pay more interest to be able to borrow money for a longer period, and investors demand higher rates to commit their savings for an extended period.
At the end of the bond’s term, the issuer returns the amount borrowed, called principal or “nominal value”. The representation below illustrates the cash flows that an investor can receive when purchasing a 3-year bond (where “t” denotes the time in years):
The vast majority of bonds on the American market usually pay semi-annual coupons, especially when they have a term of more than 1 year. The name itself, fixed income, derives from this income that is fixed over time, since most securities have pre-fixed rates, meaning you already know exactly how much you will earn, regardless of what happens with the macroeconomic scenario. It is worth mentioning that shorter-term bonds, with maturities of up to 1 year, usually pay principal + interest only upon maturity.
Main types of fixed income:
The most common type of fixed income security is the Bond (debt security), which can be issued by companies or government entities. Additionally, there are several examples of fixed income securities, such as money market instruments, asset-backed securities, preferred stocks, and derivatives.
Bonds
Bonds are essentially loans that investors make to companies or governments. In simple terms, whoever lends the money receives the principal amount back on the agreed date, in addition to regular interest payments. These loans are used to finance projects or operations, and are commonly issued by governments or companies.
Money Market Instruments
These instruments include things like commercial paper, certificates of deposit (CDs) and short-term US Treasury Bonds, which are considered by many to be the safest investment in the world. Short-term Treasury Bonds, also known as Treasury Bills, for example, are issued by the United States government and have terms ranging from one to 12 months. They do not pay interest regularly, but are sold for a price less than the face value, which represents the interest rate for investors. If a $100 Treasury Bond sells for $95, for example, that’s approximately a 5% return. Certificates of Deposit, or CDs, are the equivalent of our CDBs, and work in a similar way to T-Bills, with the difference that they are not traded on the secondary market.
Asset-Backed Securities ABS (Asset Backed Securities )
Asset-Backed Securities are like investments backed by valuable things, like money from credit cards, car loans, or home loans as collateral. ABS is a set of these investments grouped together into a single package. For those who invest, these bonds are a different option than investing in corporate debt.
Preferred
Sometimes called Subordinated Debt, these types of investments rank lower on the list of who gets money first. Preferred investments may not pay their interest or the money borrowed if the company’s financial situation worsens. This risk is called loss absorption, which is why preferred investments are considered something between loans and shares.
Who invests in fixed income?
Institutional investors and retail investors both invest in fixed income securities. They take different factors into account when making the investment decision, which may include:
Liquidity – Fixed Income Securities can be easy investments to buy and sell, being widely available in most currencies.
Diversification – Investors can choose fixed income securities to diversify their portfolios or seek safer investments, such as US government bonds.
Reconciliation with the investor’s obligations – For investors who want predictability of when and how much they will receive, to meet their obligations, fixed income securities provide a simpler way of managing money.
How to access American fixed income through TankBank?
Directly, through Bonds and CDs, or indirectly, through Mutual Funds or fixed income ETFs.
How much do I need to start investing in fixed income in the US?
With $5 dollars it is possible to buy a fraction of a fixed income ETF. To access Mutual Funds, the minimum investment is $1,000 and to access Bonds directly, the minimum is approximately $5,000.
Risks involved:
- Credit risk: There is a risk that the issuer of a debt will default on its interest or principal payments. Assess the issuer’s credit rating and financial health.
- Interest rate risk: Fixed income prices are affected by changes in interest rates. When interest rates rise, bond prices generally fall.
- Liquidity risk: Some fixed income securities, like ETFs, may have low liquidity, which can make buying or selling on the secondary market difficult. CDs do not have liquidity on the secondary market, that is, there is a need to carry the certificate until maturity.
Final considerations:
Investing in fixed income in the United States can be an interesting opportunity to diversify your investment portfolio. But remember that when evaluating an investment, it is always very important to understand your investor profile and carry out a careful analysis before making any decision.
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