Fixed Income Analysis: Understating - Importance

Fixed income analysis deals with the study of fixed income or liabilities involved in the operation of a business. This subject briefly analyzes factors like interest rate risk, credit risk, debt risk, etc. falling in different portfolios. It provides you with a wide variety of choices to buy, sell, hold or drop a particular liability. Thus, this subject holds a great significance in the analysis of an overall income of a business evaluating its potential. Here you will understand the analysis of fixed income along with its benefits and value of money.

What is a Fixed Income Analysis?

A fixed income analysis is an income-oriented method used to analyze various sources of income in a business. It evaluates every aspect of these sources very carefully to help marketers estimate the real value of the business. Some of the crucial factors playing their part in the evaluation are rate or credit risk, and factors like price variation. Thus, this analysis allows you to get acquainted with real-world events with a clear objective to learn advanced concepts.

In simple words, fixed income analysis elucidates you regarding the benefits of collateral enjoyed by the investors until its maturity. After completing its maturity period, investors receive the principal amount that they had invested initially. Among various types of fixed income prevailing in an economy, bonds issued by the government are most popular. Also, this analysis concludes the possibilities to buy, sell, hold or leave the possession of an asset. Thus, this analysis allows bondholders to enjoy the benefits of their investment after its maturity.

What Do You Understand by Time Value of Money?

Time value of money is a concept evaluating the value of money at present compared to its future value. It concludes the value of present money more than its future value due to its potential earning capacity. According to this principle, the net worth of an amount is more today as compared to its value tomorrow. This concept dramatically emphasizes the importance of time associated with determining the worth of money. The primary reasons for this variation in the value of money are inflation and possible earning capacity. Thus, in finance, an amount in the hands today can generate interest contributing to its higher present value more than the future. For example, the value of a dollar yesterday was more as compared to today; and the value of a dollar today is more than its value tomorrow.

What is Considered a Fixed Income?

Fixed income is a term of finance referring to an investment that pays back the investors regularly until its maturity. It compels the borrower or issuer to make fixed payments in regular periods to help the investor earn profits. Once reaching the maturity of an investment, investors receive the principal amount they had invested initially. Fixed income has an extensive variety of products categorized under it including some common factors like bonds, pensions, and loans. Other products like deposit certificates, savings account, market funds, and annuities are also categorized under the fixed income. If you are willing to step in the market and invest capital, you can do so in mutual funds or trade funds.

What are Examples of Fixed Income Investments?

To achieve a better understanding of fixed income investments and learn how to invest wisely, you need to consider the following example.

Suppose there is a firm that has issued a bond in the market with a face value of $10,000. The maturity period for this bond is fixed for five years with an interest rate of 5% per annum. Now, the investor will not receive back the principal amount before the bond's maturity, i.e., not before five years. For this period of five years, an interest payment called coupon payments is paid by the company in favor of investors. According to the terms and conditions of the market, investors receive a sum of $500 annually at the given rate of interest. After receiving $500 for five years, the investor becomes eligible to receive the principal amount invested initially. Thus, the time after five years is known as the bond's maturity period; and it is the time when the principal amount is paid back to the investor.

Why Is Fixed Income Important?

5 Key Significance of Fixed Income

Fixed income benefits the investors with a fixed sum of money for a fixed period until the maturity of the bond.
The payments received from fixed income also helps the investors to maintain their investment portfolio adequately.
An investor can earn huge profits if the prices of stock fluctuate periodically resulting in an increased value of that stock.
Fixed income investments guarantee substantial gains as the government of an economy strongly backs it.
Investors enjoy the benefits of high returns in a case where any claim is made in the event of liquidation of assets.

How to Calculate Fixed Income?

To calculate the fixed income, you need to evaluate the bond value at its maturity including the compound interest. Also, you need to evaluate the coupon payments to estimate the value of the bond at its maturity. It is imperative for you to calculate the total return to evaluate the fixed income return. Thus, the formula to calculate the total return can be given as follows:

Total Return: {[End value of principal + Coupon interest + Compound interest] - (Taxes + Commission) - [Begining value of principal] / Begining value of principal} * 100

Valuation of Fixed Income

Fixed income has been known as the source to earn more profits for an investor in the form of regular payments. Thus, fixed incomes in the form of bonds are more popular than equities due to is a higher rate of interest. In the technique of fixed income valuation, you can get a theoretical value of fixed incomes like a bond or equity. The valuation of fixed income includes determining the present value of an investment's interest payments in its future. This value of the investment is also known as the cash flow of a business. Apart from this, the value of an investment at its maturity is also known as its face value or par value. Therefore, the technique of valuation is used by an investor to determine the rate of return for a fixed income.

Can Fixed Income Funds Lose Money?

There is a widespread misconception among investors that fixed incomes lose or gain money. But in core financial terms, fixed income only depreciate or appreciate in the market depending on their Net Asset Value (NAV). Among various factors, the most crucial one you need to understand is that mutual funds are not safe players. Being an investor, you need to understand the difference between fixed income and bonds with a regular price. In a fixed income, it is widely observed that the value of bonds depreciates with time.

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