Fixed Income securities are debt instruments whose payout is well known before investing (assuming there is no default) provided that the instrument is held till maturity instead of trading them. There are various terms used for these fixed income instruments but they have different meanings attached to them. These terms are quite confusing in the way they are used in internet, my objective in this post will be to clarify what these terms actually mean:
- Sovereign Bonds: Bonds which are issued by central government of a country. The are assumed to have minimal default risk. Hence, spread of other bonds issued by other authorities/corporations in that country are added to the yield from sovereign bonds.
- US Treasury: These are government backed securities, mostly used in U.S terms.
- Gilt: These are also government backed securities, but are used in U.K.
- Bunds: These are German sovereign bonds with maturity of 10 and 30 years.
- Bills: These are debt instruments which have maturity period less than a year.
- Bonds: These are long-term debt instruments.
- Debenture: Depending upon the context, debentures are those fixed income instruments which is not backed by assets whereas bonds have backing of assets as collateral. In some contexts, differentiation is also done on the basis of issuer i.e bonds are those instruments which are issued by government , municipal authorities, banking corporations etc. and debentures are those instruments which are issued by companies not in banking business.
- Commercial Paper (CP): These are very short term debt instruments or IOUs issued by corporations, usually except banking and non-banking financial corporations. (Tenure is usually maximum 6-9 months)
- Certificate of Deposit (CD): These are those fixed income instruments which are issued by banking and non-banking financial corporations and is usually for a longer term than Commercial Paper.
- Hybrid Bonds: These are those bonds which have options attached to it, that’s why they are hybrid as there is derivative content embedded in it.
- Callable Bonds: These are bonds which have call options embedded. It gives the right to the issuer to call back the bonds before its maturity. It is helpful in situations of falling interest rates as the issuer can now borrow fresh money at lower rates.
- Puttable Bonds: These are bonds which have put options embedded. It gives the right to the investor to put (sell) the bonds to the issuer anytime after a threshold period before maturity. It is handy for the investor in situations of rising interest rates as he/she will have more attractive opportunities for same risk.
I sincerely hope that by now, you have more clarity on fixed income instrument terminologies. If you want me to post on any specific topic of your choice, do revert to me on the comments section. For more such articles, do follow me!