Introduction
There are two ways of capital raising, Debt Financing and Equity Financing. Entities raise money through equity dilution from various sources or transactions like IPO (Initial Public Offer), FPO (Follow-on Public Offer) and private placements. Similarly, they raise capital through offering bonds or other form of fixed income securities to public. Corporates, government and state agencies (municipal bonds) deal with fixed income securities such as Bonds, and Treasury Bill etc., these instruments are characterized by issuer, yield, face value (principal value), maturity period, interest rates or coupon, issue price and credit ratings. Credit ratings shows overall situation of risk of security, interest rates, type of fixed income security, maturity period and other factors. They do not take ownership in a company, but they have a seniority of claim over equity holders, in case of bankruptcy or default.
Characteristics of a Bond
Issuer – Firm, government, or any entity who issues the securities.
Face Value - an amount on which issuer pays interest to the bond or security holder,
Maturity Period - The maturity of an instrument shows the time period at which the principal value is due.
Issue Price - The price at which issuer issues the bonds to investors.
Coupon - The coupon rate is the interest rate that the issuer pays to the holder, there are three types of bonds on the basis of coupons
- Zero coupon bond
- Floating rate bond
- Fixed Income bond
Yield to Maturity (YTM) - It is the internal rate of return of the investment till the maturity date including return of coupons and face value of the bond.
Examples of Fixed Income Securities
- Bonds – Bond is an instrument of debt financing, which shows indebtedness of the bond issuer to the investors or security holders. In layman terms, it can be defined as loans made by investors to an issuer, with the promise of repayment of the principal amount at maturity date and regular coupon payments (generally after each interval of 6 months). The most common types of bonds are corporate bonds and government bonds, which are issued by various corporations and government respectively.
- Treasury Bills – Treasury bills or T-bills are the safest and short-term debt instrument, which are issues by government of the country. It has short term maturity period, which is less than one year. In India, it is issued in three tenors, 91-day, 182 day and 364-day maturities. While in US market, they are also available for 28 days. T-Bill is also known as zero coupon security because it does not pay coupon interest. Instead of coupon payments, it is sold at a discount rate. For example- purchasing a T-Bill, has a market price of 90, face value of 100 and discount rate is 10%.
- Money Market Instruments – Money market instruments includes commercial papers, certificate of deposits (CDs), banker’s acceptances, and repurchase agreements (repo). Even treasury bills are also an example of money market instruments, but due to its huge volume trading, it is kept separated as one of the best examples of Fixed Income Securities.
- Asset-backed Securities (ABS) – an Asset-backed Securities are fixed income securities, which are backed by financial assets, which have been “securitized” such as credit-card loans, car loans and home loans.
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