9 June 2009

Fixed Interest Securities in Age of big Government

Fixed Income Securities promise what their name says: with some exceptions they pay a fixed amount of interest every so often and promise to repay the principal at maturity. Some classes of bonds pay interest on a floating basis, give the right to convert the principal value into shares or link the interest payment to an index of inflation.
Usually the investor has the prospect of a limited return but unlimited potential of loss (if the debtor goes out of business for example).
Investing in Bonds must therefore approached with extra care and the quality of the underlying debtor must be carefully assessed.
Sometimes, however, it is possible to make significant capital gains as well. This is the case when the investor is able to benefit from a sustained move in the level of interest rates or a major change in how the market views the quality of the underlying credit.
Recently an extra risk has entered the equation. We are speaking of political risk. It is a worrying development that the US government has begun to override the legitimate interests of the debt investors in Chrysler and General Motors bonds. We will watch the impact of these interventions as they may well lead to an even more cautious approach to investing in bonds.