Definition: Fixed income trading is the process of buying and selling marketable securities yielding a steady revenue streams.
What Does Fixed Income Trading Mean?
What is the definition of fixed income trading? This form of trading is the buying and selling of securities with a fixed maturity date and pays interest (the coupon) every year. The securities are issued with the purpose to borrow money for a fixed term, for example bonds. Each bond has a fixed maturity date (when the money borrowed is paid back), a coupon and a nominal value (the capital amount borrowed). The bonds trade at a market determined interest rate called the yield to maturity (the yield).
State and local governments and private companies can issue bonds to the public to fund their operations or expansions. These investments are attractive to investors because they provide a stable income year over year until the maturity date. Traders, however, don’t want to hang onto these bonds until maturity. They want to buy them, wait until the interest rate changes, and sell them of a profit.
The market yield for bonds with different maturities can be constructed as a yield curve. This is normally referred to as the term structure of interest rates. This shows the relationship between short term and long-term interest rates in the market. Policymakers will keep a close eye on the shape of the curve, as this is a reflection of market expectations.
Let’s look at an example.
Example
Assume the government issues a 10-year 7% bond. The bond is issued at a nominal value of $1,000 and the prevailing interest rate is 8% (yield to maturity) in the market.
The government is the borrower and will pay 7% interest on the $1,000 every year. The investor who buys this will receive this 7% every year to maturity. At the end of the term, the principal of $1,000 will be returned to the investor.
The trader in the market who wishes to make a speculative profit will buy the bond at 8% yield to maturity and hopes to sell this at a lower rate. As the prevailing rate in the market falls, so the price of the bond rises.
Summary Definition
Define Fixed Income Trading: Fixed income trading means purchasing and selling securities based on steady income streams.
