FIXED INCOME DECISION CRITERIA

The fixed-income asset class is a risk-free (Treasuries) or lower-risk (credit-rated bonds) financial asset class compared to equity (stock) financial assets.  A bond (fixed-income) issuer borrows from the lender (investor) and guarantees return of principal (face value) at a certain maturity or call date, along with periodic payments of interest until maturity or call.   Indentures (bonds) and loan terms specify the obligated terms that the issuer guarantees. 

Credit risk is a measurement of the issuer’s ability (credit rating) to meet their obligation.  Generally ranked AAA-CCC, best to worse, U.S. Treasuries achieve the highest AAA rating and are considered risk-free for their ability to meet their obligation.  Investment Grade rating, generally AAA to BBB, are issuers other than the U.S. Treasury which are not risk-free, but have rated degrees of capability to meet their obligations.  High Yield (junk) rating, generally BB to C-, are issuers which have lower-rated degrees of capability to meet their obligations.

When placed (issued) on the publicly-traded bond markets, they are fixed-income securities, often with credit ratings, and exchanged at market prices daily.  They are also contained in indexes which accumulate many bonds with specified maturity and credit factors into an indexes.

Duration risk is a measurement of a bond (or index) change in value due to changes in interest rate levels (up or down) over time.  Current interest rates at given maturity and credit risk are called yield.  The market price of a bond is set to the yield which the market demands from bonds depending on currently prevailing interest rates (which may be different from the issuer’s initial interest rate).  The longer maturity of a bond (or a bond index), the greater the change of market value of the bond when the yield to maturity demanded by the market changes.  If current market yields are higher than bond-issue interest rates, the bond price will decline to reach the current market yield to maturity.  If current market yields are lower than bond-issue interest rates, the bond price will increase to reach the current market yield to maturity.

The current yield to maturity (YTM) is the exact, market based expected return of a particular bond or index.  Yield is always stated in nominal terms, exact total rate of yield on top of the maturity value (including the decline or increase from purchase price dependent on trading premium or discount price).  The value of the yield which investors receive is increased or decreased by the amount of actual inflation over the investor holding period.  The yield which the investor receives over the holding period, less the realized inflation over the holding period, is called the real yield.  It is real because the value of the interest yield is decreased by the increase of prices (inflation) which decrease the economic value (real value) interest received.