Fixed income investing can offer a number of benefits, such as providing a predictable source of income, helping to preserve capital and offering attractive diversification benefits to your portfolio.
Fixed income investments are not all created equal, and therefore it is important to hold a diversified mix of fixed income investments in your portfolio. Each segment, however, reacts differently to changes in interest rates, the economic outlook and other market factors.
This chart generally illustrates the various risk and potential return levels for T-Bills and a variety of bond segments.
T-Bills, Commercial Paper and Bankers’ AcceptancesTreasury bills (T-Bills) and other money market securities such as commercial paper and bankers’ acceptances are considered to be the safest segment of the fixed income market. Issued at a discount, T-Bills are short-term debt securities issued or guaranteed by federal, provincial or other governments. The stated interest rates for T-Bills are fixed when issued, but values fluctuate based on changes to the central bank rate. A T-Bill’s return is calculated based on the difference between the price paid and the par value (also known as the denomination or face value). T-Bills mature at par (typically 90 or 180 days) and do not pay fixed interest payments like most bonds. Unlike T-Bills, commercial paper and bankers’ acceptances are issued by corporations. A commercial paper is a negotiable promissory note with a term of a few days to a year and is not generally secured by company assets. A bankers’ acceptance is a short-term promissory note bearing the unconditional guarantee (acceptance) of a major chartered bank. Bankers’ acceptances offer superior yields to T-Bills, with higher quality and liquidity than most commercial paper issues.
Investment-grade corporate bonds
Issued by large corporations, these corporate bonds are often called “investment grade” because they are issued by very creditworthy companies with high credit ratings. Standard & Poor’s assigns credit ratings of AAA, AA, A or BBB to investment-grade bonds. Investment-grade corporate bonds offer a slightly higher stream of income than government bonds because they are not guaranteed by a government. The difference in rates (interest-rate spread) between corporate and government bonds generally rises and falls as a result of investor confidence, investors’ willingness to take risks, the outlook for the economy and growth in corporate profits. (Interest-rate spread – or simply spread – is used to describe the difference in rates between different types of bonds.) With investment-grade corporate bonds, investors assume the risk that the issuing company might not be able to make its interest and principal payments. The risk of investment-grade corporate bonds, however, tends to be very low.
High-yield corporate bonds
High-yield corporate bonds are sold by corporations that do not have the same high credit rating as investment-grade issuers. Standard & Poor’s assigns credit ratings of BB or lower to high-yield bonds. Historically, high-yield bonds have provided investors with a higher yield than investment-grade corporate or government bonds. This higher yield helps to compensate investors for the risk of the issuing company not making its interest and principal payments. Due to their higher risk of default, the interest-rate spread between high-yield bonds and government bonds is wider than the spread between investment-grade corporate bonds and government bonds.
To learn more about fixed-income investing, talk to your financial advisor.