Question

1. What are the determinants of a fixed interest debt financial instrument?

Answer 1

Below are the main determinants of a fixed interest debt financial instrument :

(1)Credit Risk : Safety of a fixed income investor's principal depends upon the issuer's credit quality and ability to meet its financial obligations. Issuers with lower credit ratings, generally, have to offer higher yields to the investors to compensate for additonal credit risk. A change in either the issuer' s credit rating or the market's perception of the issuer's business prospects will affect the value of its outstanding securities.

(2) Interest Rate Risk : Market value of the securities will be inversely affected by movements in interest rates. When the rates are rising, market prices of existing debt securities will fall as the demand increases for new-issue securities with the higher rates.As the prices decline, yields are brought into line with the prevailing rates

(3) Purchasing Power Risk : Fixed Income investors oftern focus on the real rate of return, i.e.actual rate of return minus the rate of inflation. Rising inflation has a negative impact on real rates of return because inflation reduces the purchasing power of the investment income and its principal.

(4) Price Risk : Investors who need access to their principal, prior to its maturity, have to rely upon the available market of the securities.  Although, investors of fixed rate capital securities, may take the advantage of exchange listing for retail offerings to sell their securities before maturity, price received may be more or less the purchase price as a result of these dynamic risk factors.