Trading bonds and other debt instruments
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What is Fixed-Income Trading?
Fixed-income trading is the process of trading fixed-income securities over-the-counter (OTC). The fixed-income market offers low transaction costs, a competitive market structure, and a large, diverse collection of market participants. The fixed-income securities market is dominated by institutional investors.
What is a Fixed-Income Security?
A fixed-income security, or debt security, is a claim on a particular periodic income stream from interest paid on borrowed funds. Fixed-income securities are named so because they guarantee a stream of income that is determined by a fixed formula.
There are several different types of financial instruments that make up the fixed-income market, but the most commonly traded are government or corporate bonds.
Factors Affecting Fixed-Income Trading
The following factors affect fixed-income trading:
Credit/default risk
Credit/default risk refers to the likelihood that the issuer of a security may be unable to:
- Pay interest and/or principal in a timely fashion
- Comply with the provisions of a bond indenture
- The probability of credit/default risk depends on the issuer’s ability to meet their financial obligations and on their creditworthiness. There is a negative correlation between credit rating and yield. The lower the issuer’s credit rating, the higher the yield (to compensate for higher credit risk) and vice-versa. A change in the issuer’s credit rating affects the value of their outstanding fixed-income securities.
Interest rate risk
There is a negative correlation between the price of debt securities and interest rates. However, there is a positive relationship between interest rate and yield. Interest rate risk arises when a change in interest rates has an adverse impact on the yield of debt securities.
Reinvestment rate risk
This refers to the probability of a decline in the interest rate causing a decline in the options available for reinvesting the interest income received at higher or similar rates in the market.
Price risk
Price risk results when, due to an adverse movement in prices, the investor does not receive the expected price when selling a bond or other debt security in the secondary market. This is particularly relevant for investors who want to access the principal amount before the maturity date of the security, as they have to rely on the prevailing market price of the security, which may be higher or lower than the price they originally paid for the security.
Purchasing power risk
Fixed income investors look at the real rate of return on their investments.
Real Rate of Return = Actual Rate of Return – Rate of Inflation
Inflation reduces the purchasing power of the principal invested and the investment income. Thus, inflation has an inverse relationship with the real rate of return. The higher the inflation rate, the lower the real rate of return (and vice-versa). If the inflation rate is high, there is a possibility that an investor’s real rate of return on their fixed-income investments may be negative. For example, if a bondholder is receiving 3% interest payments on a purchased bond, but the inflation rate is 5%, then the bond holder’s real rate of return is negative (-) 2%.
Reasons to Invest in Fixed-Income Securities
To achieve different investing goals, an investor can invest in different types of fixed-income securities:
Capital appreciation: Those aiming to make maximum capital gains should primarily invest in low-rated securities like emerging market debt or high-yield bonds. If interest rates are likely to fall, investing in government bonds and long-term maturity corporate bonds should also result in strong capital gains. Corporate bonds typically offer higher returns than government bonds due to the fact that they carry more risk.
Income: All fixed-income securities (with the exception of zero-coupon bonds) provide some form of regular interest payments to investors. This makes the fixed-income market especially attractive to investors whose main investment goal is providing themselves with a steady income.
Safety: Risk-averse investors seeking primarily the safest investments should invest in securities with short maturity periods (less than 5 years) to reduce interest rate risk, and in securities with a high credit rating – to avoid default risk. Some debt securities that meet both of these criteria are U.S. Treasury bills, money market instruments (especially certificates of deposits), short-term corporate debt, and municipal bonds issued by municipalities with a high credit rating.
- Tax advantages: Investors seeking to maximize their after-tax income often favor investing in municipal bonds, as the income received from them is usually tax-free.
There is a wide variety of fixed-income investments and investing strategies available for you to consider. Make sure to thoroughly research any fixed-income opportunity prior to making an investment. Because many bonds have maturity dates of 10 years or more, purchasing a bond means tying up a substantial amount of your investment capital for a long period of time. Therefore, you want to make sure that you’re making the best use of your money with your choice of investments.
Additional Resources
Fixed Income Bond Terms
Basis Point Value
Negative Correlation
Risk Averse
See all fixed income resources
FAQs
Fixed income trading involves the buying and selling of fixed income securities by fixed income investors. Fixed income securities include bonds such as investment-grade or high-yield corporate bonds, government bonds and inflation-linked bonds.
What is a fixed income trader? ›
A fixed income trader is a financial professional who executes security trades on behalf of institutional and retail clients based on equity research relating to fixed income investments. They generally work for broker-dealers and banks.
Is fixed income trading profitable? ›
Here are the advantages of fixed-income trading instruments: Steady Returns: Fixed-Income trading instruments earn investors a steady stream of income because of the regular predetermined interest or dividend payouts. As the payouts are predetermined, investors know how much they can earn and at what time.
Why do people trade fixed income? ›
Income: All fixed-income securities (with the exception of zero-coupon bonds) provide some form of regular interest payments to investors. This makes the fixed-income market especially attractive to investors whose main investment goal is providing themselves with a steady income.
What is the difference between equity trading and fixed income trading? ›
Equity securities are financial assets that represent shares of a corporation. Fixed income securities are debt instruments that provide returns in the form of periodic, or fixed, interest payments to the investor.
How to get into fixed income trading? ›
Education & Qualification. Having a degree in the Finance domain betters the chances of an aspirant becoming a Fixed income trader. These degrees can range from a Bachelor's in Business Administration with a Finance specialization to a Master's degree in the same domain.
Can you day trade fixed income? ›
Fixed income ETFs, unlike individual bonds, offer intraday electronic trading and are often more liquid than the underlying baskets of bonds they track.
Can I be a millionaire with trading? ›
In conclusion, while it is possible to become a millionaire through forex trading, it is not a guaranteed path to wealth. Achieving such financial success requires a combination of education, skills, strategies, dedication, and effective risk management.
What is the most profitable type of trading? ›
Conclusion. The most profitable form of trading varies based on individual preferences, risk tolerance, and market conditions. Day trading offers rapid profits but demands quick decision-making, while position trading requires patience for long-term gains.
How much does a fixed income trader make at Goldman Sachs? ›
Total Salary Range for Goldman Sachs Fixed Income Trader
The estimated total pay range for a Fixed Income Trader at Goldman Sachs is $235K–$419K per year, which includes base salary and additional pay. The average Fixed Income Trader base salary at Goldman Sachs is $169K per year.
Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Any fixed income security sold or redeemed prior to maturity may be subject to loss.
Where can I trade fixed income? ›
Tradeweb® Direct is the go-to source and one of the largest fixed income marketplaces in the U.S. for financial advisory firms, registered investment advisors (RIAs), traders and buy-side investors who need fast, reliable market data for their fixed income information needs.
How does fixed income lose money? ›
Bonds also come with credit risk, particularly in lower-rated bonds. This is the risk that the issuer of the bond will default and be unable to pay interest or return an investor's principal at maturity. “Inflation can also erode the purchasing power of fixed-income returns over time,” Willardson said.
Is it better to invest in equity or fixed income? ›
Equity markets offer higher expected returns than fixed-income markets, but they also carry higher risk. 1 Equity market investors are typically more interested in capital appreciation and pursue more aggressive strategies than fixed-income market investors.
How to invest in fixed income? ›
How can I invest in fixed income funds? Investors who prefer to invest through funds can consider either bond mutual funds or bond exchange-traded funds (ETFs). Bond mutual funds and ETFs can offer professionally managed, diversified investments for investors, for a fee.
How big is the fixed income market? ›
The global fixed income market totals about $130 trillion in outstanding debt. By comparison, global equities markets total about $42 trillion. Given the scale of the fixed income market, it is critical for traders to keep up with the latest global electronic trading trends driving execution in the market.
How much do bond traders make? ›
How much does a Bond Trader make? As of Apr 30, 2024, the average annual pay for a Bond Trader in the United States is $96,774 a year. Just in case you need a simple salary calculator, that works out to be approximately $46.53 an hour. This is the equivalent of $1,861/week or $8,064/month.
What does a fixed income sales person do? ›
What is the Fixed Income Sales role? The sales representative is primarily a relationship manager acting as the conduit between the firm's investment banking products (research and trading) and the customer (institutional portfolio manager).
Can you make money in fixed income? ›
Investors who hold fixed income generate a return even when the stock market is down. Fixed-income investing is also a way to earn passive income: When investors own a fixed-income instrument, such as a bond or CD, they collect the income without having to manage any other considerations regarding the holding.
