Fixed income

Some people lend money to help others.

A big company or a government might need money. They can borrow it from people. This is called a bond.

The borrower must pay the money back. They also pay extra money. This extra money is the same each time.

This helps people have steady money. It is good for people who want a set plan. They can count on the payments.

It is a way to help a business grow.

Helping others can help everyone succeed.

Sometimes, a company or a government needs to borrow money. They might need it to buy land or new tools. They can do this by issuing bonds. A bond is a type of fixed income. This means the borrower must pay a set amount of money on a set schedule.

The amount of money borrowed is called the principal. The borrower also pays extra money called a coupon. This coupon is the interest. The date when the borrower must pay the principal back is called maturity.

Bonds are different from stocks. When you buy a stock, you own a small part of a company. Companies do not have to pay you back if they own stocks. But with bonds, they must pay. If a company goes broke, bond holders are paid first. This offers more protection.

There are many kinds of bonds. Governments can issue them. Companies can issue them too. Some bonds even change with inflation. This helps keep the money's value high. But there are risks. A borrower might not be able to pay. This is called default.

Fixed income is a way for people to invest money. It works when a borrower promises to pay back a set amount. This borrower could be a large company or even a government. They must follow a specific schedule for their payments. These payments are fixed, which means the amount does not change. This makes the income very predictable for the person lending the money.

There are several important parts to how these investments work. The amount of money borrowed is called the principal. The extra money paid as a thank-you is called the coupon. This coupon is the annual interest paid as a percentage. Every bond has a maturity date, which is the end of the deal. On this date, the borrower must return the full principal. Sometimes, a legal contract called an indenture lists all these rules.

History shows us how important these tools can be for big projects. For example, the Central Pacific Railroad issued a bond on January 1, 1867. This bond helped pay for the construction of the transcontinental railroad. It had a fixed annual interest rate of 6 percent. The principal and interest were even payable in United States gold coins. This shows how bonds help build things that connect the world.

Different groups of people use many types of fixed income. Governments issue sovereign bonds in foreign currencies or local bonds in their own. State and local governments use municipal bonds for big spending projects. Companies can also issue corporate bonds to grow their businesses. Some special bonds, called inflation-indexed bonds, change with the cost of living. These are used to protect the value of money over time.

Investing in fixed income is not without its own risks. A borrower might face financial hardship and fail to pay. This is known as a default. There is also inflation risk, where money loses its buying power. Interest rate risk happens when market rates change after you buy. People also worry about currency risk if exchange rates move. Large groups like pension funds often look for these steady payments.

Fixed income is a specific type of investment. In this arrangement, a borrower or issuer is legally required to make payments. These payments follow a fixed amount and a fixed schedule. This predictability makes fixed income different from other investments like stocks. While stocks represent equity, fixed income securities are often called bonds. Investors use these to gain a steady return on their money.

To understand how this works, we must look at the specific mechanics. A company or government needs money to grow or build things. They can issue a bond to raise this capital. The amount of money borrowed is called the principal. This is also known as the face value or par value. The issuer must pay interest, which is called the coupon. This coupon is expressed as a percentage of the principal. Finally, the bond has a maturity date. This is the specific date when the issuer must return the full principal to the lender. The contract that holds all these rules is called an indenture.

There are many different types of borrowers in the world. Governments are major players in this market. They can issue sovereign bonds in foreign currencies. They also issue government bonds in their own local currency. State and local governments use municipal bonds to pay for big projects. Agencies backed by governments issue agency bonds. Private companies can also participate by issuing corporate bonds. Sometimes, companies use bank loans instead of bonds. Even bank lending, like car loans or mortgages, can be turned into asset-backed securities, or ABS.

History shows us how these tools can fund massive human achievements. For example, the Central Pacific Railroad needed money for a huge project. They issued a bond on January 1, 1867. This bond helped finance the construction of the transcontinental railroad. It had a fixed annual interest rate of 6 percent. The issuer promised to pay the principal and interest in United States gold coins. This shows how fixed income can connect distant places through large-scale infrastructure.

Investors choose fixed income for different reasons. Many are looking for a secure and constant return. Large institutional investors are the main participants in this market. This group includes pension plans, mutual funds, and insurance companies. They often have long-term needs to meet. For instance, a pension fund needs predictable cash flows to pay retirees. A retired person might use coupon payments as a dependable way to live. They can collect the interest without spending their original principal.

Not all fixed income works exactly the same way. Some bonds are designed to fight inflation. These are called inflation-indexed bonds. Examples include US Treasury Inflation Protected Securities, or TIPS. They also include UK Index Linked Gilts. These bonds adjust their principal and interest based on a price index. In the US, they use the Consumer Price Index, known as the CPI-U. This helps investors protect the purchasing power of their money. If inflation rises, the value of the bond adjusts upward to keep pace.

However, every investment carries various risks. One major risk is default risk. This happens if the issuer cannot make their scheduled payments. If they miss a payment, they are in default. This can lead to legal action or bankruptcy. There is also inflation risk, where rising prices reduce what the money can buy. Interest rate risk occurs when market rates change after an investment is made. Currency risk is another factor if exchange rates shift. Finally, liquidity risk is the danger of not being able to sell the security quickly for a fair price.