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Fixed income is an asset class built on debt instruments that pay investors a predetermined stream of interest and return principal at a set maturity date. When you buy a bond, you are lending money to a government, corporation, or municipality. In return, they pay you regular interest payments called coupons and repay the loan amount when the bond matures. The CIBC Investor's Edge explains it plainly: bonds and fixed income are often used interchangeably, though fixed income includes certificates of deposit, preferred shares, and money market instruments beyond just bonds.
The US bond market is the world's largest, with the Federal Reserve, US Treasury, and institutional investors including pension funds and insurance companies among its biggest participants.
Every fixed income instrument shares three fundamental elements. The face value (also called par value) is the principal amount returned to you at maturity. The coupon rate is the annual interest rate expressed as a percentage of the face value. The maturity date is when the issuer repays the principal.
Raymond James explains this with the IOU analogy: the issuer borrows from you and commits to pay interest and return principal. If you hold a $1,000 bond with a 5% annual coupon, you receive $50 per year, paid in two $25 semi-annual installments, until maturity.
Fixed income covers a wide range of instruments across issuers and structures.
This relationship is the single most important mechanic in fixed income investing. When market interest rates rise, existing bonds with lower coupons become less attractive, so their prices fall until the yield matches the new market rate. When rates fall, existing bonds with higher coupons become more valuable.
Think of it like a fixed-rent lease: if market rents rise above what your tenant pays, your lease asset loses market value. Schroders notes this inverse relationship in their fixed income primer: changes in interest rate expectations are the primary driver of bond price movements.
Duration is the fixed income metric that tells you how much a bond's price will change for a 1% change in interest rates. A 10-year duration means roughly a 10% price decline if rates rise 1%. A 3-year duration means only a 3% price decline for the same rate move.
Longer-maturity bonds have higher durations and more interest rate sensitivity. Short-term bonds carry lower duration risk but also offer lower yields. Managing duration is the central risk management task in a fixed income portfolio.
Fixed income serves two primary roles in a portfolio: capital preservation and income generation. Schroders points out that fixed income typically moves opposite to equities, providing a cushion when stock markets fall.
Insurance companies and pension funds depend heavily on fixed income because their long-term liabilities require predictable cash flows. Institutional demand for long-dated, high-quality bonds helps keep yields lower on those instruments than pure supply-and-demand for capital would otherwise produce.
The difference in yield between a corporate bond and a government bond of the same maturity is called the credit spread. It reflects the market's assessment of default risk. Investment-grade corporate bonds carry small spreads. High-yield bonds carry large spreads that can widen dramatically during economic stress.
When the economy weakens, credit spreads widen because investors demand more compensation for default risk. When growth is strong and defaults are low, spreads compress and high-yield bonds often outperform investment-grade bonds.
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