There are many different kinds of fixed-income securities. Most of them are purchased by large institutional funds because they are sold in denominations of $1,000, and odd lots are considered anything under $1 million in face value. This makes it somewhat difficult for average individual investors to actively participate in this market. However, mutual funds that specialize in fixed-income portfolios are excellent ways for an individual to invest in fixed-income bonds.
Types of Bonds
All bonds are considered fixed-income investments; so-called because they remit a stated amount of interest annually, in payments every six months, to the holders of those bonds. At maturity, they pay the face amount of interest, which is $1,000 per bond. This gives a reliable flow of income to the investor. There are U.S. Treasury bonds, government agency bonds, corporate and municipal bonds. Notes are bonds that have maturities of 10 years or less.
Synthetic bonds are derivatives. The term "derivative" means the security you are buying is derived from a contracted relationship involving real securities that are packaged in such a way as to result in a specific performance experience for the investor. For example, if you want a 10-year note that pays higher interest if market interest rates rise, but there is no such bond available to buy, you might buy a synthetic bond. It has been it has been structured through the purchase or short sale of certain U.S. Treasury bonds, plus contracted interest payment relationships with banks or corporations, to create an interest flow that increases with market rates and returns your principal on a maturity date in ten years. Credit default swaps, or CDCs, that figured prominently in the credit crisis of 2008, were synthetic securities.
Preferred stock pays a dividend that is set when the stock is issued. Common stock pays a dividend when it is voted by its board of directors, but it is not a reliable amount since it can be changed or cancelled by the board. Because a preferred stock dividend is stipulated as part of the issue, it is considered a fixed-income security and trades according to market interest rates. The dividend represents a certain percentage return on the invested money so, as market interest rates rise, the dollar price of the preferred stock declines.
Mortgage and Asset-Backed Bonds
Asset-backed bonds are backed by a pool of financial assets such as credit card receivables, consumer loans, auto loans and home equity loans. Mortgage-backed bonds and mortgage pass-throughs are also asset backed but they are not normally referred to as asset-backed securities. The interest paid by the packages of loans that collateralize these bonds goes toward the interest paid to the bond investor. ABS bonds generally repay principal on maturity but mortgage-backed bonds tend to pay both interest and principal on a monthly basis.