Understanding Debt Securities

From an Investor’s point of view a “Debt” or a “Fixed Income security” is defined as a fixed and recurring income generation asset. This asset generates regular income for the investor in the form of coupon interest and is typically redeemable after a stated period, which is mentioned in the nomenclature of the security itself. For Example- a 10 years US Treasury bond is trading at 5% pa with face value of $1000. Here, investor will receive $50 every year till its maturity i.e. 10 years period and upon maturity its face value of $1000.

There are various kinds of debt securities available in the market today such as Government Bond, Corporate Bond, Commercial Paper, Preferred Stock, Certificates of Deposits, Zero Coupon Bond, Collateralized Bond and Municipal Bond.

The debt securities, typically a bond is priced in terms of the yield that it will generate to the investor. In simple words, yield is the return that the bond will generate provided it is held by the bondholder till the maturity.

It is important to understand the inverse relationship of Bond Price with the Bond yield. This mechanism is attributable to the fact that when the yield rises in the market, the bondholder starts to face the heat in form of the Interest rate risk. This motivates the bond holder to sell the bonds while the demand for that bond is negligible, as nobody would like to invest at a lower interest rate. This ultimately leads to the fall in Bond prices.

The latest report “The Russell Investments/ASX Long-term Investing Report” seems to throw quite interesting facts about returns from different asset classes particularly equity and fixed income.

As per the data, Australian shares market has given a mere gross return of 4% over 10 years span. Market expects some level of future volatility on account of global economic slowdown, US- China trade & sea war and higher interest rate regime in US as compared to unchanged low rates in US since over 28 months now.

Coming to Australian Fixed Income and Global Fixed Income, the two have performed decently in both 10 years’ (6.2% and 7.1% respectively) as well as 20 years’ span (5.9 and 7.2% respectively).

Investing involves analysing opportunities for capital growth, risk spreading & diversification as well as strategic decisions. A prudent investor must carefully study his investment goals and match his investment decisions with risk tolerance.

Investors seeking tremendous capital growth opportunities may choose equity investment. On other hand, risk averse investors can consider keeping government and corporate bonds as part of their investment portfolio, offering safer returns. However, although debt securities seem to be safer than equity securities, it is very important to consider the associated risks as well, in terms of default risk of issuers, inflation risk, liquidity risk and market interest rate fluctuations risk.

Unlike other countries, Australia’s corporate bond market, significantly larger than its government bond market, performed exceedingly well during global financial crisis of 2008. Credit rating agencies such as Moody’s/Fitch/S&P assigned stable ratings to such bonds. The market has experienced very limited number of defaults and ratings downgrade since couple of years.

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