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Basics on investment into Fixed Income Securities |
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Fixed income investments are an important tool to provide safety to the capital and also to minimise the volatility in returns. Most investors know fixed income investments as Fixed Deposits. Fixed income investments have to be primarily evaluated based on three characteristics -
- coupon or interest
- maturity or tenor
- issuer
The interest rate offered on a fixed deposit would depend on the issuer and tenor.
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What is a bond?
Traditionally, when a borrower takes a loan from a lender, the borrower enters into an agreement with the lender specifying the date when he would repay the loan and what return or interest the borrower would provide to the lender for providing the loan. This entire structure can be converted into a form where in the loan can be made tradable by converting it into smaller units and pro rata allocation of interest and principal. This tradable form of the loan is termed as a debt instrument.
Example of interest or coupon on fixed income investment: An investment of Rs. 1 Lakh in a Fixed Deposit or bond that pays 8% p.a. for 5 years will add Rs. 8,000 to one's income each year over the next 5 years. At the end of 5 years, the investor will get back his original investment of Rs. 1 Lakh.
The interest rate offered by the borrower to the lender depends on two factors a) credit rating b) tenor of the bond. The less credit-worthy (as reflected through the credit rating) pay higher interest, as do borrowers who want money for many years. For example, the bond of a company in a cyclical or new business will pay, or yield, more than a bond from an established company, since the established company is more likely to service the debt on time.
Tenor of the bond: A five-year bond typically yields more than a one-year bond - the compensation for being locked in and unable to reinvest the principal if interest rates rise in future.
Interest rate risk affects the value of bonds and is a major risk to all bondholders who would like to trade the bond before maturity. As interest rates rise, bond prices fall and vice versa. The rationale is that as interest rates increase, the opportunity cost of holding a bond decreases since investors are able to realise greater yields by switching to other investments that reflect the higher interest rate.
For example, an 8% bond is worth more if interest rates decrease since the bondholder receives a higher fixed rate of return relative to the market, which is offering a lower rate of return as a result of the decrease in rates.
| Interest Rates |
10-year bond |
% movement |
| 5% |
1,231.65 |
23.17% |
| 6% |
1,147.20 |
14.72% |
| 7% |
1,070.24 |
7.02% |
| 8% |
1,000.00 |
0.00% |
| 9% |
935.82 |
-6.42% |
| 10% |
877.11 |
-12.29% |
As seen from the above example we have taken a 10 year bond offering 8% yield and analysed the impact of interest rate movements on the price of the bond.
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HDFC Bank offers you:
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Section 54 EC - Capital Gains Bond |
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Tax exemption for transferring gains of long term capital assets.
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8% Savings (Taxable) Bonds |
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Choose from cumulative and non-cumulative bond options.
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