What Is Fixed Income Trading?

Fixed income trading is a simple way to give your portfolio a solid foundation. It’s investing in government bonds, Treasury bills and other debt securities backed by large institutions. The investor effectively loans money to bond issuers and receives dependable, regular payouts according to an interest rate — hence the fixed income component.

Fixed income investing offers a sense of stability to your financial strategy. It delivers a predictable income over a long stretch of time and grounds your portfolio in stable securities.

How Does Fixed Income Trading Work?

In fixed income trading, a large entity like the government or a corporation issues bonds to raise capital for certain projects. Investors buy the bonds, agreeing, in effect, to loan the entity the principal amount. Trading often takes place in over-the-counter (OTC) or after-hours markets or alternate exchanges.

A fixed income security comes with a “term,” anywhere from one month to several years. Over that term, the bond issuer regularly pays the investor interest fees, usually monthly. When the term ends and the bond reaches maturity, the bond issuer pays back the loan principal in full.

The instruments used in fixed income trading are low-risk, low-maintenance bonds, mutual funds or exchange-traded funds (ETFs). They’re generally passively managed, although some high-yield, higher-risk bonds may be watched over more closely.

Types of Fixed Income Securities

Some of the most common fixed income securities include:

• Government, corporate, municipal or agency bonds
• Treasury bills, bonds or notes
• Asset-backed securities
• High-yield bonds
• Convertible bonds

Several other financial instruments can be creatively included in a fixed income investment strategy.

How to Become a Fixed Income Trader

Fixed income trading is a little more complex than buying and selling stock shares. But the process for investing in fixed income securities is relatively straightforward and doesn’t differ too much from investing in stocks.

Research and Analysis

Prep work is a key part of any investment strategy. For fixed income trading, study the current market conditions, interest rate movements and general trends in bonds and bills. When you're considering a specific security, look into the issuer’s credit rating, yield rate, liquidity, transaction fees, history and other pertinent factors. Assess your own level of risk tolerance as well.

Trading Strategies and Decision-Making

Map out your game plan for fixed income trading. You may want to maintain a combination of short- and long-term securities. Or you’ll want to blend consistent bonds with high-yield, riskier investments. Your personal goals will have an impact on your trading decisions involving liquidity, tax implications, maturity length, risk tolerance and other factors.

Execution of Trades

Once you’ve picked the fixed income instruments you want, you can make transactions through your brokerage account. Although many bonds are available on the OTC market, you can also find mutual funds, ETFs and other instruments in fixed income markets. 

Settlement and Post-Trade Activities

Review your transaction to make sure it went through smoothly. While waiting for the security to mature, monitor your investment and the interest rate payments. Keep on the lookout for opportunities to reallocate your funds, balance your portfolio and adjust your investment strategy.

Advantages of Fixed Income Trading

Several unique aspects of fixed income trading offer investors great benefits.

Diversification Opportunity

Financial experts believe having a diverse investment portfolio helps to manage risk. Fixed income funds and ETFs are relatively instant ways to spread your funds across different investment sectors and securities.

Constant Income Generation

Fixed income securities make regularly scheduled payouts of interest rate fees. This consistency is more reliable than a dividend from a stock, which isn’t guaranteed.

Potential for Capital Appreciation

Although most fixed income securities center on consistent revenue rather than assertive growth, some offer the possibility of capital growth. Convertible bonds, for example, may offer dividends if the bond issuer has great price gains. Some fixed income securities may rise in overall value in line with current interest rates.

Risks in Fixed Income Trading

Fixed income investments are largely considered safe bets, but like all investments, they carry some potential risks.

Interest Rate Risk

The value and appeal of fixed income securities are subject to interest rate fluctuations. Rising interest rates can depreciate the value of long-standing assets with extensive maturity periods and modest yields. The opposite is true when interest rates decline, making new bonds less enticing.

Credit Risk

Since you’re loaning money to entities in fixed income securities, your investment hinges on their ability to pay you back. While most government bonds are safe from credit issues, some corporate bonds may be affected if disaster strikes and the issuer defaults on the loan.

Liquidity Risk

Fixed income investments with long-term maturity tend to be set-it-and-forget-it types. Aside from the regular interest payments, it’s usually not easy to convert the securities into cash before they mature. This could become an issue in times of economic hardship.

Factors Affecting Fixed Income Trading

Just like every investment vehicle, fixed income trading is affected and influenced by several common financial factors.

Interest Rates

Fixed income asset valuation is directly linked to interest rate changes. Long-term bonds are more susceptible to interest rate changes over the course of the investment. Sudden decisions on interest rates by the central bank can complicate short-term bond values. All the factors that affect interest rates — economic health, inflation, speculation and so forth — impact your fixed income securities.

Credit Risk

There’s always the chance that a bond issuer may default on their payments or see their credit rating downgraded. Low-rated bonds may experience unfortunate credit spreads when the difference between the yields of high-risk and low-risk bonds widens. Since credit is so closely tied to economic health, it will come into play with fixed income vehicles.

Market Liquidity

Fixed income investments are usually, but not always, less liquid than other instruments. However, their value can be subject to liquidity in the general marketplace. Highly liquid markets can make pricing and transaction costs fairly stable. But illiquid markets can make the bonds’ value and pricing difficult to determine.

Economic Indicators

Market conditions and international financial differences affect the economy in some ways that could impact your fixed income investments. Every common economic indicator — gross domestic product, inflation, employment figures, the consumer price index and more — can affect the value and health of fixed income securities.

Ready to Get Fixed Up?

The investment market is complex and versatile, with many options for investing. Fixed income trading is a generally low-risk avenue for investment health. They’re reliable sources of regular revenue via interest payments. They can give your portfolio diversification. Many are backed by institutions that are truly too big to fail, like governments and large corporations. 

With their dependability, controlled risk and defined terms, fixed income securities can play an effective and consistent role in your long-term investment strategy. It’s worth taking the time to find out how they can work for you.

Frequently Asked Questions