Home' Trinidad and Tobago Guardian : October 4th 2015 Contents Delving into the world of
investments can be a
daunting one for the less
experienced investor. One
of the first questions per-
sons often ask themselves
is "What should I invest in?" That question
is often accompanied by a series of other
questions including those that would assist
them in determining the various risks
New investors may want to start investing
in less risky assets such as fixed income
investments which include bonds, treasury
bills and fixed deposits. Fixed income instru-
ments are investments which provides a
return in the form of fixed periodic payments
and the eventual return of principal at matu-
rity. The fixed periodic payments are interest
payments or coupon payments.
While these investments are generally
considered to be more conservative and less
risky than equity investments, bonds and
other fixed income investments do still carry
a variety of risks that investors must be
In this article, we examine three of the
risks inherent to fixed income investments;
credit risk, interest rate risk and liquidity
Also known as default risk, this is the risk
of loss resulting from the issuer/borrower
failing to make full and timely payments of
interest and/ or principal. When assessing
a bond, it is important to consider both the
probability of default and the portion of a
bond s value that may be lost in the event
of a default.
Realising its importance, institutions
known as credit rating agencies conduct
objective and independent assessments of
countries, companies and securities, assigning
a credit rating. The ratings provide investors
with information that assists them in deter-
mining the likelihood of issuers of debt obli-
gations being able to make the scheduled
payments on time. Some of the better known
international credit rating agencies include
Standard and Poor s, Moody s and Fitch.
Standard and Poor s ratings, for example,
range from AAA (the most secure/highest
credit quality) to D, which means the issuer
has already defaulted. T&T has been assigned
an A rating.
Bonds are classified as either investment
grade or non-investment grade (commonly
referred to as junk or high yield bonds).
While investment grade bonds are gen-
erally deemed to be less risky, with a greater
promise of repayment, these bonds tend to
have a lower yield than the non-investment
grade bonds which must pay a higher rate
of interest to compensate for
Here we see a principle being introduced
known as the risk-return tradeoff, which
states that potential return rises with
SBG12 PERSONAL FINANCE
SUNDAY BUSINESS GUARDIAN www.guardian.co.tt OCTOBER 4 • 2015
Unit Trust Corporation
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Interest rate risk
Interest rate risk is the risk that an investment s
value will decline due to rising interest rates. As interest
rates change, the yield on most bonds are adjusted
accordingly. There exists an inverse relationship between
interest rates and the price of a bond, ie as interest
rates fall, the price of a bond rises. Conversely, as
interest rates rise, the bond price falls.
To illustrate this: let s suppose you bought a $1,000
par value bond with a three-year maturity and a 2.5
per cent coupon rate. You will therefore earn $25 each
year that you own the bond.
Let s further assume that after one year, you decide
to sell the bond, and that new bonds with similar
characteristics are now being issued with 5.0 per cent
coupons. To encourage persons to buy your bond, you
will have to discount its price, since investors are now
able to invest their $1,000 in a bond that pays them
more; $50 per year. If a bond is being held until maturity,
interest rate risk is less of a concern for investors.
To better understand liquidity risk, think of a car
that you own, but wish to sell. If several individuals
are interested in purchasing the vehicle, there is a high
possibility that you will be able to sell the vehicle at
a price that is reflective of its market value. If however,
there are little to no potential buyers, you may be
forced to lower the price, possibly incurring a loss, to
attract buyers and ultimately, sell the vehicle. The
same principle applies for bonds.
Liquidity risk is the risk of being unable to buy or
sell investments quickly for a price that is reflective
of its true value. When a bond is said to be liquid,
there generally exists an active market of investors
buying and selling the bond.
Government bonds and larger issues by well-known
corporations are typically very liquid. Some bonds are
however illiquid and trade very infrequently, which
can present a problem if trying to sell before maturity.
In general, a bond with greater frequency of trading
and a higher volume of trading provides fixed income
investors with more opportunity to purchase or sell
the security and thus has less liquidity risk. Three
main factors that can affect liquidity risk are the size
of the issue, the frequency with which the issuer issues
bonds and the credit quality of the issuer. Generally,
issues that are smaller in size have less trades and
consequently, higher liquidity risk.
Additionally, the lower the credit quality of the
issuer, the higher the liquidity risk. Unexpected down-
grades of credit ratings on corporate bonds can result
in increased credit and liquidity risk.
Diversification is an excellent means of minimising
many of these risks inherent in fixed income securities.
In the world of fixed income, diversification takes on
many forms, and can be done based on bond type,
bond issuer (such as government or corporate bonds;
duration (short-, intermediate-, and long-term bonds),
credit quality and industry.
Mutual funds offer an attractive alternative to building
your own investment portfolio as they provide diver-
sification and professional investment management
at a lower initial investment. At the Unit Trust Cor-
poration, we offer several mutual funds which cater
to the diverse needs of the wider public. Fixed income
investors should consider our TT Dollar Income Fund
and US dollar Income Fund which give access to a
diversified portfolio of fixed income securities.
For our corporate clients looking for fixed income
investments, the UTC Corporate Fund is also an option.
These mutual funds make the process of investing
less daunting as they significantly reduce and even
eliminate some of the risks faced by fixed income
investors, including those mentioned above. Call or
visit us for more information.
Investing in fixed income
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