Fixed interest – demystifying the jargon

In the current investment climate many investors are keen to understand more about fixed-interest and cash options. For the majority of investors, cash as an asset class is relatively self-explanatory, but fixed-interest investing may appear more complex.

Generally speaking, fixed-interest investments include term deposits, debentures or bonds, and can be of a secured or unsecured nature.

Fixed-interest as an investment class definitely has more than its fair share of associated jargon. Some of the key terms are highlighted and explained below.

Bond: A certificate of debt, generally issued by a corporation, government or government agency. The bond holder is paid interest throughout the life of the investment, which is generally at least two years.

Coupon: The interest payment on a bond.

Debenture: A type of unsecured debt, which is issued (sold) by a company.

Duration: A weighted average maturity of all future cash flows of a bond. In more practical terms, when trading bonds, duration is used as a measure of a bond’s sensitivity to changes in interest rates/yields i.e. a bond’s price volatility. The longer the duration, the more sensitive the bond or portfolio should be to changes in interest rates.

Face value: The dollar value of the debt instrument purchased.

Maturity: The amount of time before the borrower needs to repay the bond. Bonds with maturity dates in the very near future (a year or so) typically pay less interest than bonds with longer maturity dates. This is because investors take on added risk with bonds that don't mature for a long time, so a higher yield compensates for this.

Secured & Unsecured Debt: When a company issues the fixed interest investment, the debt may be secured against assets of the company (‘secured debt’) or it may not (‘unsecured debt’). If the company issuing the debt goes bankrupt, the investors with secured debt are usually repaid before those holding unsecured debt.

Yield: The annual return on investment.

Yield Curve: The yield curve, a graph that shows the relationship between bond yields and maturities, is an important tool in fixed-interest investing. Investors use the yield curve as a reference point for forecasting interest rates, pricing bonds and creating strategies for boosting total returns. The yield curve has also become a reliable leading indicator of economic activity. A downward sloping curve usually means that interest rates will fall over time, while an upward curve usually means interest rates will rise.

Yield to Maturity (YTM): The rate of return on a bond if it is held until maturity. YTM typically increases as interest rates rise. This is because the value of the bond declines so you can purchase the bond at a discount to its notional face value.