Fixed income analysis is the valuation of fixed income

Fixed income

Fixed income refers to any type of investment that is not equity, which obligates the borrower/issuer to make payments on a fixed schedule, even if the number of the payments may be variable....

 or debt securities, and the analysis of their interest rate risk

Interest rate risk

Interest rate risk is the risk borne by an interest-bearing asset, such as a loan or a bond, due to variability of interest rates. In general, as rates rise, the price of a fixed rate bond will fall, and vice versa...

, credit risk

Credit risk

Credit risk is an investor's risk of loss arising from a borrower who does not make payments as promised. Such an event is called a default. Other terms for credit risk are default risk and counterparty risk....

, and likely price behavior in hedging

Hedge (finance)

A hedge is an investment position intended to offset potential losses that may be incurred by a companion investment.A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, many types of...

 portfolios

Portfolio (finance)

Portfolio is a financial term denoting a collection of investments held by an investment company, hedge fund, financial institution or individual.-Definition:The term portfolio refers to any collection of financial assets such as stocks, bonds and cash...

. The analyst might conclude to buy, sell, hold, hedge or stay out of the particular security.

Fixed income products are generally bonds

Bond (finance)

In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...

 issued by various government treasuries

Treasury

A treasury is either*A government department related to finance and taxation.*A place where currency or precious items is/are kept....

, companies or international organizations. Bond holders are usually entitled to coupon payments at periodic intervals until maturity

Maturity (finance)

In finance, maturity or maturity date refers to the final payment date of a loan or other financial instrument, at which point the principal is due to be paid....

. These coupon payments are generally fixed amounts (quoted as percentage of the bond's face value) or the coupons could float in relation to LIBOR or another reference rate

Reference rate

A reference rate is a rate that determines pay-offs in a financial contract and that is outside the control of the parties to the contract. It is often some form of LIBOR rate, but it can take many forms, such as a consumer price index, a house price index or an unemployment rate...

.

Valuation

The cash flow

Cash flow

Cash flow is the movement of money into or out of a business, project, or financial product. It is usually measured during a specified, finite period of time. Measurement of cash flow can be used for calculating other parameters that give information on a company's value and situation.Cash flow...

 of a fixed income product generally consists of several coupon payments over the period of the bond's life, and repayment of the principal at the time of maturity. Since these cash flows occur at several times in the future, the "Time Value of Money

Time value of money

The time value of money is the value of money figuring in a given amount of interest earned over a given amount of time. The time value of money is the central concept in finance theory....

" approach is used to find the "Present Value" of each cash flow. The sum of all the present values of the bonds cash inflows of the bond is its theoretical value.

Following are the typical questions an analyst finds answers for:

• Does the real interest rate built into the yield make sense?
• Is the real interest rate in line with the expected GDP growth rate (in case of treasury bonds) or earnings growth rate (in case of corporate bonds)?
• What is the expectation of GDP growth ? Where do we stand in the economy cycle?
• Where do we stand in the business cycle of the particular company, or economic cycle of the particular country?
• Is there any change expected in the basic real interest rate in the near future?
• Do the prevailing monetary and economic conditions force any monetary easing or tightening so that the base real rate will get changed?
• Is the inflation condition worsening or improving?
• Are the financial authorities in the country pro-acting or re-acting to the forces of inflation and economic conditions?
• Is the risk premium built into the yield enough to compensate for the risks?
• What are the likely risks the market has currently priced into the premium and what are the new or hidden risks the market has overlooked and to what extent?
• What is the nature and volume of demand for a particular bond?
• What is nature and volume of supply for a particular bond?

The demand for fixed income products comes from banks, insurance companies, pension fund companies, endowment organisations, External Government Treasuries, individual investors like retirees and widows who need regular fixed cash in-flow.

The Fixed Income Analyst covers the term structure or yield curve

Yield curve

In finance, the yield curve is the relation between the interest rate and the time to maturity, known as the "term", of the debt for a given borrower in a given currency. For example, the U.S. dollar interest rates paid on U.S...

 analysis too. This is in simple terms, analysing all bonds issued by the same entity for different maturities (like US Govt 2yr bond, 10yr bond, 20 year bond). Such analysis enables one to understand the pricing differences between maturities comparable inter-market bonds (like Eur 2yr, 5yr and 10yr bunds)

The approaches for analysing fixed income products are broadly as follows: Fundamental approach; Technical Approach; relative value

Relative value

Relative value is the attractiveness measured in terms of risk, liquidity, and return of one instrument relative to another, or for a given instrument, of one maturity relative to another...

 Approach.

Further reading

• Dr Andrew Colin "Fixed Income Attribution" (London, Wiley & Sons. January 2005) ISBN 978-0-470-01175-1

See also

• Bond convexity
  Bond convexity
  In finance, convexity is a measure of the sensitivity of the duration of a bond to changes in interest rates, the second derivative of the price of the bond with respect to interest rates . In general, the higher the convexity, the more sensitive the bond price is to decreasing interest rates and...
  
  
• Bond duration
  Bond duration
  In finance, the duration of a financial asset that consists of fixed cash flows, for example a bond, is the weighted average of the times until those fixed cash flows are received....
  
  
• Bond options
• Callable bonds
• Credit risk
  Credit risk
  Credit risk is an investor's risk of loss arising from a borrower who does not make payments as promised. Such an event is called a default. Other terms for credit risk are default risk and counterparty risk....
  
  
• Discount rate
  Discount rate
  The discount rate can mean*an interest rate a central bank charges depository institutions that borrow reserves from it, for example for the use of the Federal Reserve's discount window....
  
  
• Floating rate
• Hedging
  Hedge (finance)
  A hedge is an investment position intended to offset potential losses that may be incurred by a companion investment.A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, many types of...
  
  
• Interest
  Interest
  Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
  
  
• Interest rate risk
  Interest rate risk
  Interest rate risk is the risk borne by an interest-bearing asset, such as a loan or a bond, due to variability of interest rates. In general, as rates rise, the price of a fixed rate bond will fall, and vice versa...
  
  
• Mortgage loan
  Mortgage loan
  A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...
  
  
• Preferred stock
  Preferred stock
  Preferred stock, also called preferred shares, preference shares, or simply preferreds, is a special equity security that has properties of both an equity and a debt instrument and is generally considered a hybrid instrument...
  
  
• Prepayment risk
• Swaps
• Yield curve
  Yield curve
  In finance, the yield curve is the relation between the interest rate and the time to maturity, known as the "term", of the debt for a given borrower in a given currency. For example, the U.S. dollar interest rates paid on U.S...
  
  
• Andrew Kalotay
  Andrew Kalotay
  Andrew Kalotay is a Hungarian-born finance professor, Wall Street quant and chess master. He is best known as an authority on fixed income valuation and institutional debt management...
  
  
• Fixed Income Analysts Society Hall of Fame