Fixed income: deposits, bonds and debt funds
What does a deposit pay, what does a bond yield, and why do bond prices fall when rates rise?
12 of 12 chapters published
Chapters
Beginner
- What a bond isA loan you can sell. The borrower promises a fixed payment on fixed dates and your money back at the end — which makes the return knowable in advance, and makes everything that can go wrong a question about the borrower.
- Who borrowsThe central government, the states, public sector undertakings and companies — in roughly that order of safety, and roughly that order of yield. Who is promising is the first question, because the promise is all you own.
- Price and yield move oppositeA bond's payments are fixed, so the only thing that can adjust is its price. When new bonds pay more, yours is worth less — and that seesaw is the single most surprising fact in fixed income.
- How to buy bondsIndividuals can now open an account directly with the Reserve Bank and buy government securities with no intermediary and no charge. That is a genuinely new thing, and most people who should know about it do not.
Intermediate
- Reading a yieldCoupon, current yield and yield to maturity are three different numbers, and only one of them answers the question you are asking. Quoting the wrong one is how a mediocre bond gets sold as a good one.
- DurationOne number that says how much a bond or a fund will move when rates move. It is the most useful figure in fixed income and the one least often looked up, even though every debt fund publishes it.
- Credit risk and ratingsA rating is one agency's opinion on whether a borrower will pay, bought and paid for by the borrower. SEBI says plainly that it is not a recommendation and that you have no contract with the agency if it turns out wrong.
- Debt fundsA debt fund is a portfolio of bonds, so it has a price that moves and a credit book that can deteriorate. It is not a deposit with a better rate, and the schemes that most resemble one are the ones holding the shortest paper.
Advanced
- The yield curvePlot yield against maturity and you get a line that is usually upward sloping, occasionally flat, and rarely inverted. Its shape is the clearest statement the market makes about what it expects — and it is free to read.
- Tax on fixed incomeInterest is taxed as ordinary income, which is the least favourable treatment in the system. That single fact changes the comparison between a bond and almost everything else — and the headline yield is always a pre-tax number.
- Real return on bondsA fixed coupon has no defence against prices rising. Subtract tax and then inflation from a 7.5% bond and what is left is frequently close to nothing — which is the real risk of fixed income, and the one that never looks like one.
- Building a fixed income allocationDecide what each rupee is for, match the maturity to the date, and take credit risk only where you are paid enough and diversified enough. Everything else in this subject is detail in service of those three sentences.