Why fixed income matters
Fixed income can provide income, capital preservation, liability matching, diversification, and exposure to interest rates and credit. The label does not mean returns or payments are fixed: floating-rate coupons change, defaults occur, inflation erodes purchasing power, and bond prices move before maturity. Portfolio behavior depends on duration, credit quality, optionality, liquidity, currency, and seniority.
How it is applied
Investors define eligible issuers, maturities, ratings, currencies, structures, and benchmarks. Analysis estimates yield, duration, spread, default probability, recovery, cash-flow timing, and embedded options. Portfolio construction manages curve exposure, concentration, liquidity, reinvestment, and liability needs. Foreign bonds require separation of local bond return from currency return and hedging cost. Portfolio analysis can decompose expected return into starting yield, income, roll, spread change, rate change, defaults, recovery, currency, and trading costs. Duration limits connect those sources to plausible losses. Credit exposure should be tested separately from interest-rate exposure because they can behave differently in a recession.
Portfolio example
A bond portfolio has modified duration of five years. A parallel 1 percentage-point rise in yields implies an approximate 5% price decline before convexity, income, spread, and curve effects. Holding to maturity may recover par if the issuer pays, but an investor selling earlier realizes the market value.
How to interpret it
Higher yield usually compensates for some combination of duration, credit, liquidity, complexity, or currency risk. Yield is not guaranteed return. Government debt can have little default risk in local currency yet substantial inflation and rate risk. Investors should compare yield with expected losses, financing cost, tax, and the investment horizon.
Limitations and common misconceptions
Duration approximations weaken for large or nonparallel rate moves. Ratings and reported yields can lag deterioration. Callable, convertible, and securitized bonds have path-dependent cash flows. Market liquidity can disappear during stress. Inflation, currency, and reinvestment can materially alter real outcomes, requiring security-level analysis and scenarios. The asset-class label does not imply stable value. Long-duration government bonds, floating-rate loans, inflation-linked securities, and distressed credit respond to different risks and can experience very different drawdowns.
Sources and further reading
- Fixed-Income Markets: Issuance, Trading, and FundingCFA Institute
- Overview of Asset AllocationCFA Institute