Many businesses face challenges when parking funds. Market volatility, unpredictable returns, and the risk of capital loss make it difficult for businesses to park funds confidently.This is where fixed-income securities come into play.

In today’s KOFFi break, we will understand fixed-income securities in-depth. We will cover types, benefits of fund parking in fixed-income securities, risks involved, and most importantly, how corporates can use it for fund parking.

What are Fixed-Income Securities?

Fixed-income securities are debt investment instruments that provide regular income payments at fixed intervals until their maturity. Essentially, they are loans made by an investor to a borrower, which could be a corporation, government, or other financial entity.

In return for the loan, the borrower promises to pay interest at fixed intervals and return the principal amount at maturity. This predictable income stream makes fixed-income securities an attractive option for conservative investors.

Let’s see some of the types of fixed-income securities.

Types of Fixed Income Securities

There are several types of fixed-income securities. Every fixed income securities has its own characteristics and uses. Let’s dive into the most common ones:

Treasury Bills

Treasury Bills (T-Bills) are short-term debt instruments, or money market instruments, issued by the government to meet short-term liquidity needs. They are typically issued with maturities of 91 days, 182 days, or a maximum of 364 days. Treasury Bills are sold at a discount to their face value, and the difference between the purchase price and the face value represents the interest earned by the investor.

For Example, a 182-day treasury bill with a face value of ₹100, can be bought at a discounted price of ₹97. After 182 days or after maturity, buyers can receive ₹100, which allows them to make a profit of ₹3.

• Key Features:
  • High liquidity and low-risk
  • Backed by the Government
  • Ideal for short-term fund parking
  • No periodic interest payments; the return is realized at maturity.

Commercial Paper

Commercial Paper (CP) is an unsecured, short-term debt instrument issued by large banks or corporations to finance their working capital needs. Commercial papers usually have maturities ranging from a minimum of 15 days to a maximum of one year and are typically issued at a discount to face value.

• Key Features:
  • Higher yield compared to Treasury Bills
  • Higher risk due to lack of collateral and security
  • Used by companies with high credit ratings
  • No periodic interest payments; the return is realized at maturity

Corporate Bonds

Corporate Bonds are long-term debt securities issued by companies to raise capital for expansion, acquisitions, business growth, paying bills, and other needs.

When a company sells corporate bonds to investors, it raises the necessary capital for its needs. In exchange, investors receive regular interest payments, which can be at a fixed or variable rate. Once the bond’s term ends, known as ‘maturity,’ these interest payments stop, and investors receive their initial investment back.

• Key Features:
  • Higher returns compared to government securities, reflecting higher risk.
  • Periodic interest payments provide a steady income stream.
  • It can be secured or unsecured, with varying credit ratings.

Government Bonds

Government Bonds, also known as sovereign bonds, are issued by the Central or State Government of India to finance their expenditures. These bonds are considered low-risk as they are backed by the Government and typically offer lower interest rates compared to corporate bonds.

• Key Features:
  • Low risk, making them suitable for conservative investors.
  • Regular interest payments and principal repayment at maturity.
  • Long-term fund parking, often ranging from 5 to 40 years.

Certificates of Deposit

Certificates of Deposit (CDs) are fixed-income deposits offered by banks and financial institutions and are governed by the Reserve Bank of India. They are short-term investments with maturities ranging from 1 to 3 years.

• Key Features:
  • Guaranteed returns with fixed interest rates
  • Minimum amount of deposit starts at ₹1,00,000
  • Fully-taxable under the Income Tax Act
  • Penalties may apply for early withdrawal
  • No lock-in period

Benefits of Fund Parking in Fixed Income Securities

Parking funds in fixed-income securities offers several advantages:

• Stability: Fixed-income securities provide regular interest payments, offering a stable and predictable passive income stream.
• Lower Risk: As compared to equity funds, fixed-income securities generally carry lower risk.
• Security: Most of the fixed-income securities are issued by the Government of India, Reserve Bank of India, or high-rated corporations.
• Diversification: Including fixed-income securities in your portfolio helps diversify risk and balance potential volatility from equity investments.
• Capital Preservation: These instruments are ideal for preserving capital while earning a steady return, making them suitable for conservative investors and businesses.

How Corporates Use Fixed Income Instruments for Fund Parking

Corporates or medium enterprises often utilize fixed-income securities for parking their surplus funds due to the following reasons:

• Liquidity Management: Companies use short-term instruments like Treasury Bills and Commercial Papers to manage their liquidity efficiently. This ensures that they have quick access to cash whenever needed.
• Risk Management: Parking funds in high-quality fixed-income securities helps companies manage their risk and mainly preservation of capital while earning returns.
• Yield Enhancement: Strategically parking funds in a mix of short-term and long-term fixed-income instruments helps enhance the overall yield on surplus funds.

Risks Associated with Fixed-Income Securities

Although fixed-income securities are generally considered safer than equities, they still carry certain risks:

• Interest Rate Risk: As the interest rate fluctuates, the value of fixed-income securities can change. When interest rates rise, the value of existing fixed-income securities typically falls.
• Credit Risk: There’s always a chance that the issuer might not be able to make the interest or principal payments. This concern is more relatable in the case of corporate bonds and commercial paper.
• Inflation Risk: Fixed-income securities may not keep pace with inflation, leading to a reduction in purchasing power over time.
• Reinvestment Risk: If the interest rate drops, then you need to repark your funds at a lower rate, potentially reducing overall returns.

If you strategically park your funds by analyzing these major risks, then it will be easier for you to get good returns from fixed-income securities.

Final Thoughts

Fixed-income securities are essential for creating a balanced investment portfolio. They help businesses and investors by providing stability, regular income, and preserving capital. Knowing the different types of fixed-income securities and understanding their benefits and risks is key to making smart investment choices.

Whether you’re an individual investor aiming to park funds and get steady returns or a corporation wanting to manage surplus funds efficiently, fixed-income securities can be a powerful tool for reaching your financial goals.