Q: Explain different kinds of fixed income investments. Rank by risk from high to low.
Fixed-income investments are financial instruments that provide a regular stream of income in the form of interest or dividend payments. Here are some common types of fixed-income investments ranked by risk from high to low:
- High-yield bonds (also known as junk bonds): These bonds are issued by companies with lower credit ratings, and they offer higher interest rates to compensate for the increased risk of default. High-yield bonds are considered the riskiest type of fixed-income investment.
- Emerging market bonds: These are bonds issued by governments or companies in developing countries. They typically carry higher interest rates compared to developed market bonds due to the increased risk associated with political and economic instability, currency fluctuations, and lower credit ratings.
- Corporate bonds: Corporate bonds are debt securities issued by companies to raise capital. The risk level of corporate bonds depends on the creditworthiness of the issuing company. Investment-grade corporate bonds (issued by companies with higher credit ratings) are less risky than non-investment grade bonds (issued by companies with lower credit ratings).
- Municipal bonds: Municipal bonds are debt securities issued by state, city, or local governments to finance public projects like schools, roads, and hospitals. They are generally considered lower risk than corporate bonds because they are backed by the taxing authority of the issuing government. However, the risk can vary depending on the financial health of the issuer.
- Government bonds (e.g., U.S. Treasuries): Government bonds are issued by national governments and are considered low-risk investments due to their backing by the full faith and credit of the issuing government. U.S. Treasury bonds, bills, and notes are considered among the safest fixed-income investments because they are backed by the U.S. government.
- Government-backed securities (e.g., agency bonds, mortgage-backed securities): These are fixed-income investments issued by government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac or other government agencies. They are considered low-risk investments because they are implicitly backed by the government, although the level of risk may vary depending on the specific security.
- Certificates of deposit (CDs) and savings accounts: CDs are time deposits offered by banks that pay a fixed interest rate for a specified period. Savings accounts are deposit accounts that pay interest on the balance. Both CDs and savings accounts are considered low-risk investments because they are insured by the Federal Deposit Insurance Corporation (FDIC) up to a certain limit.
It’s important to note that the risk level of fixed-income investments can be influenced by various factors, such as interest rate risk, credit risk, and inflation risk. Diversifying your fixed-income portfolio across different types of investments can help mitigate these risks.