What is a Fixed-Interest Security?
A fixed-interest security is a type of financial instrument that provides regular, predefined interest payments to investors. They are considered more secure compared to equities because they offer lower risk levels and provide less scope for capital appreciation. However, they often yield a better interest return than equities, making them attractive to risk-averse investors.
Examples of Fixed-Interest Securities
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Gilt-Edged Securities:
- Also known as “Gilts,” these are high-grade bonds issued by a sovereign government to finance its expenditure.
- Example: UK Treasury Gilts.
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Bonds:
- Debt securities issued by corporations or governments to raise capital.
- Example: US Treasury Bonds, Corporate Bonds.
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Preference Shares:
- Shares that provide dividends at a fixed rate and have preference over common shares in dividend payment and asset liquidation.
- Example: Preferred Stock in a utility company.
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Debentures:
- Unsecured bonds relying on the creditworthiness and reputation of the issuer rather than collateral.
- Example: Corporate Debentures issued by General Electric.
Frequently Asked Questions (FAQs)
Q1: What makes fixed-interest securities less risky compared to equities?
A1: Fixed-interest securities entail lower risk largely due to their defined interest payments and principal repayment at maturity. This stability contrasts equities, where dividends and capital gains are significantly influenced by market fluctuations.
Q2: Can fixed-interest securities provide capital appreciation?
A2: While the primary appeal of fixed-interest securities is the stable income from interest, there is limited scope for capital appreciation compared to equities. The prices of these securities can rise due to a decline in interest rates or improving credit ratings of the issuer but to a lesser extent.
Q3: How is the yield of a fixed-interest security calculated?
A3: Yield is typically calculated as the annual interest payment divided by the current market price of the security. This could differ from the coupon rate, especially if the security is bought or sold at a discount or premium to its face value.
Q4: Are fixed-interest securities suitable for long-term investments?
A4: Yes, they can be suitable for long-term investments, especially for risk-averse investors looking for regular income and a return of capital at maturity.
Q5: Can fixed-interest securities be sold before maturity?
A5: Yes, they can be sold on the secondary market before maturity. The sale price would depend on the prevailing interest rates and market conditions.
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Gilt-Edged Securities:
- High-grade bonds issued by a country’s government with a low risk of default.
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Bonds:
- Debt instruments where the issuer is obligated to pay interest and principal over specific periods.
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Preference Shares:
- Stocks with fixed dividend payments and priority over common stocks in dividend distribution and liquidation.
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Debentures:
- Unsecured bonds typically relying on the issuer’s credit rating rather than collateral.
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Equities:
- Ownership shares in a corporation, providing potential for capital growth but with higher risk.
Online References
Suggested Books for Further Studies
- “The Bond Book” by Annette Thau
- “Investing in Bonds For Dummies” by Russell Wild
- “Fixed Income Securities” by Bruce Tuckman
- “Bond Markets, Analysis, and Strategies” by Frank J. Fabozzi
Accounting Basics: “Fixed-Interest Security” Fundamentals Quiz
### What defines a fixed-interest security?
- [x] Provides regular, predetermined interest payments.
- [ ] Equity investment in start-up companies.
- [ ] Real estate investment with variable returns.
- [ ] Commodities with fluctuating market prices.
> **Explanation:** Fixed-interest securities provide regular and predetermined interest payments, making them more stable investment options compared to equities.
### Are the yields from fixed-interest securities usually higher or lower than those from equities?
- [ ] Higher and more volatile.
- [x] Generally higher but more stable.
- [ ] Lower and unstable.
- [ ] Equally volatile as equities.
> **Explanation:** Fixed-interest securities often offer a better yield than equities as they provide stable returns and are considered lower risk.
### What is the primary risk associated with debentures?
- [ ] Collateral risk.
- [x] Creditworthiness of the issuer.
- [ ] Variable interest rate risk.
- [ ] Immediate value depreciation.
> **Explanation:** Debentures are unsecured bonds, and their value depends on the creditworthiness and reputation of the issuer.
### Which of the following is an example of a fixed-interest security?
- [x] US Treasury Bonds.
- [ ] Common Stocks.
- [ ] Real Estate Investment Trusts (REITs).
- [ ] Commodities Futures.
> **Explanation:** US Treasury Bonds are a type of fixed-interest security providing regular interest payments.
### What distinguishes preference shares from common shares?
- [x] Fixed dividend and pay before common shares in events of liquidation.
- [ ] Higher risk and greater capital appreciation potential.
- [ ] Volatile interest rates and market dependence.
- [ ] No dividends and higher risk.
> **Explanation:** Preference shares offer fixed dividends and hold priority over common shares concerning dividend payments and asset liquidation.
### How is the yield of a fixed-interest security calculated?
- [x] Annual interest payment divided by the current market price.
- [ ] Total asset value divided by the interest rate.
- [ ] Annual revenue divided by operational costs.
- [ ] Net earnings plus asset depreciation.
> **Explanation:** The yield of a fixed-interest security is typically calculated as the annual interest payment divided by its current market price.
### What is the risk level of 'Gilt-Edged Securities' compared to corporate bonds?
- [x] Lower due to government backing.
- [ ] Higher due to economic fluctuations.
- [ ] Equal, depending on issuer reputation.
- [ ] Unrelated to bond type.
> **Explanation:** Gilt-edged securities generally have a lower risk level compared to corporate bonds as they are backed by a sovereign government.
### Can fixed-interest securities be sold before their maturity date?
- [x] Yes, they can be traded on the secondary market.
- [ ] No, they can only be held to maturity.
- [ ] Only if the issuer defaults.
- [ ] Only during the initial offering period.
> **Explanation:** Fixed-interest securities can be sold before maturity on the secondary market, though the price may fluctuate based on market conditions and interest rates.
### Which of the following securities do not fall under fixed-interest securities?
- [ ] Corporate Bonds.
- [x] Common Shares.
- [ ] Preference Shares.
- [ ] Government Debentures.
> **Explanation:** Common shares do not provide fixed interest payments and are not considered fixed-interest securities.
### Why might an investor choose fixed-interest securities?
- [x] For lower risk and predictable income.
- [ ] For high-risk, high-reward strategies.
- [ ] To exclusively seek capital appreciation.
- [ ] For high volatility and quick market gains.
> **Explanation:** Investors choose fixed-interest securities for their lower risk and predictable income, making them suitable for conservative investment strategies.
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