A fixed income security refers to any type of instrument or contract that pays a regular or fixed return. For example if you lend money to an entity or individual (the borrower), who has to pay you interest once each month (as specified in an agreement) you have in fact been issued a fixed income security.

Governments typically issue fixed income securities in varying forms, and in varying currencies, in order to raise funds to finance varying public projects and programmes. When an investor buys these securities and investor is in fact lending the Government money to finance these programmes.

Companies also issue fixed income securities, the proceeds from these are generally used to finance the growth of the business, through the purchase of equipment or to finance the acquisition of other businesses. Corporate fixed income securities are generally considered to be less risky than stock issued from the same companies. The reason for this is that in the event of bankruptcy and liquidation of the company lenders are given greater priority in terms of the receipt of funds from the proceeds of the liquidation of the company.

From an investment standpoint fixed income securities are generally considered to be the safest class of investments. Those that are familiar with the concepts of increased risk for increased return will also understand that as a result fixed income investments tend to give the lowest returns amongst the various classes of investments. Now given the broad range of potential borrowers one would be correct to assume that fixed income securities having different issuers are likely to have varying risks associated with the unique characteristics of each borrower.

The main focus in fixed income securities as it is with any borrower lender relationship is the borrower’s ability to repay the loan. Amongst countries the United States is considered to be the least risky nation with respect to its ability to meet its debts, and as a result the returns (as measured by interest) on securities issued tend to be the lowest. Countries with weak incomes as measured by Gross Domestic Products and those with unstable governments need to offer a higher interest rate in order to get potential lenders to buy their securities.

It’s the same with companies as well; companies that are strong tend to pay lower interest than companies that are relatively weak. A company in a sector that is vibrant and growing would likely attract more lenders than one in a sector that is on the decline. Financial analysts constantly look at various governments and companies and compare them to see if they are being properly compensated in terms of the returns they are getting on their fixed income investments. This entails monitoring factors and developments that would affect a government’s or company’s ability to repay the loans that they have outstanding.

For the average investor monitoring the myriad factors that affect a company’s ability to repay is daunting, fortunately however financial institutions often perform this function and provide the information to their investors for free. So take advantage.

Bob Russell is the assistant vice- president, structured finance at Mayberry Investments Limited. He can be contacted at bob.russell@mayberryinv.com