Fixed Income: Bonds, bills and debentures

Fixed Income is an investment product that offers access to debt held by companies and institutions. Therefore, they are products that recognise a debt for the entity that issues them, while the investor in a fixed income product becomes a creditor of the product's issuing entity. Examples of fixed income include bonds, debentures, etc. In other words, investing in Fixed Income means lending money to companies or public institutions, becoming their creditor or lender.

In general, the profitability and the time horizon is known from the outset and some issue regular interest payments. The investment has a set maturity and the principal invested is recovered at maturity or during the life of the investment.

The amount of interest and its payment date are laid down from the outset in most cases.

Fixed Income confers economic rights to the investor (but not voting rights) that the issuer must respect. If the company is liquidated, the creditor (Fixed Income investor) has priority over the shareholders (Variable Income investor).

These are short-term public debt securities issued by the Spanish Public Treasury, which are used to finance the State. The main difference compared to other Fixed Income instruments such as bonds and debentures are the terms. The Treasury currently issues bills at 3, 6, 9 and 12 months.

As these are short-term securities, their price fluctuations in the secondary market are usually small; therefore, they entail less risk for investors who expect to sell or may need to sell these securities in the market before they mature.

Treasury bills are securities issued at a discount, which means that the assets entitle the right to charge a set amount on a given day and buy that right for a lower amount. The interest generated by the Treasury Bills is obtained by calculating the difference between the acquisition price and the redemption amount at maturity.

The minimum investment amount is €1,000. Acquisitions of a higher amount must always be in multiples of €1,000.

You become a creditor of the company or state, which promises to return the money plus interest within a certain period. Therefore, you assume the issuer's credit risk; in other words, the risk that the debtor will not be able to pay its debt ("default").

The interest payment is received in the form of a recurring coupon and, finally, the principal is returned. Unlike the dividends when investing in shares, coupon payments do not change depending on the profits generated by the company – they are a fixed amount that is known at the time of issue (hence the name "fixed income"). Bond investors must analyse the company's ability to repay the debt before it looks at its growth or the profits it generates. Obviously, the better the business evolves and the higher the profits, the greater the company's ability to pay. Fixed income investors do not benefit directly from this, although they do have greater security regarding the debtor's solvency and, therefore, the probability of the debt being repaid.

The fluctuation risk is assumed in the bond price. Like shares, the market constantly values bonds. Their price is therefore not fixed and if you decide to quit your investment before the bond matures, you assume the market risk – namely, . the variation in the bond price. At all times, the market requires a return in order to become a creditor: this is the "IRR" (Internal Rate of Return). Although the coupon is fixed, investors can achieve a lower or higher return by buying the bond above or below the issue price, respectively. Therefore, changes in the IRR will cause variations in the bond price. Although this only affects you if you sell the bond before maturity.

As such a broad and developed market, the investment universe is extensive. You can choose very different bonds based on the following criteria:

• Coupon: the payment that you will receive from time to time (quarterly, half-yearly, yearly, etc.) according to the interest agreed upon during the issue.
• Coupon type: it can be fixed or variable. The variable coupon depends on a benchmark interest rate, such as the three-month Euribor. A variable bond coupon could be, for example, Euribor 3 months + 100 bp).
• IRR: the internal rate of return measures the bond's profitability. At the time of issue, the IRR may coincide with the coupon, but when the bond begins trading, the IRR required by the market may vary (and cause changes in the price). You will have to continually assess whether the bond's IRR is more or less than your required return in order to become a creditor of the issuer.
• Term and maturity: the date on which the principal is received and the bond is settled. The time that elapses between the bond's issue and its maturity is called the term. This is one of the fundamental criteria for determining the Internal Rate of Return (IRR), since of course the longer the term, the higher the IRR required.
• Rating: the rating on the credit quality of the bond or issuer granted by a specialised agency. It measures the default risk. Depending on the rating, the bonds are divided into two groups: investment grade (high credit quality bonds) and high yield (low credit quality bonds). The rating is another of the fundamental aspects to determine the IRR, since a worse rating entails higher risk and higher profitability should be required.
• Order of precedence: in the event of bankruptcy, this determines who receives the money first, depending on whether it is senior debt (payment preference) or subordinated. In either case, bond investors are ahead of shareholders when it comes to recovering the investment.

There are also other criteria common to other types of investments, such as when you select shares: sector, geography or size of the issuing company.