Question

Discuss the aspects of exchange traded fixed interest securities that might influence your decision to invest.

Answer 1

Interest Rate Risk

The market value of the securities will be inversely affected by movements in interest rates. When rates are rising, market prices of existing debt securities will fall, as demand increases for new-issue securities with the higher rates. As prices decline, yields are brought into line with the prevailing rates. When rates are falling, market prices will rise, because the higher rates on outstanding debt securities will be more valuable

Credit Risk

The safety of a fixed-income investor’s principal depends on the issuer’s credit quality and ability to meet its financial obligations. Issuers with lower credit ratings usually have to offer investors higher yields to compensate for the additional 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.

Purchasing Power Risk

Fixed-income investors often focus on the real rate of return, or the actual 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 principal

Price Risk

Investors who need access to their principal prior to maturity have to rely on the available market for the securities. Although investors in fixed-rate capital securities may take advantage of the exchange listing for retail offerings to sell their shares prior to maturity, the price received may be more or less than the purchase price as a result of these dynamic risk factors.