Fixed income instruments are monetary contracts between parties that generally provide income on a fixed schedule, though the income amount can vary [1, 2]. Failure to meet these contractual obligations constitutes a default [3].
Fixed income instruments can be categorized by several first principles:
1. **Nature of Coupon or Principal Payments**
* **Fixed-Rate Instruments:** These instruments have an interest rate (coupon rate) that is set at the outset and remains constant throughout their term [2-6]. The coupon is the product of the principal (par value or face value) and the coupon rate [5, 7].
* *Examples:* Plain-vanilla bonds, straight-coupon bonds [4, 6].
* **Floating-Rate Instruments:** The coupons on these debt securities are periodically reset based on a reference or benchmark rate [4, 6, 8].
* *Examples:* Floaters, Inverse Floating-Rate Notes (IFRNs) [4, 8, 9].
* **Zero-Coupon Instruments:** These instruments do not make periodic interest payments. Instead, the investor receives a single payment (the face value) at maturity, and the return is derived from the difference between the purchase price and the face value [4, 6, 10, 11].
* *Examples:* Treasury STRIPS (Separate Trading of Registered Interest and Principal of Securities), Commercial Paper (CP), Zero-Coupon Callable Notes [4, 6, 10-12].
2. **Maturity Term**
* **Money Market Instruments (Short-Term):** These instruments have an original term to maturity of one year or less [2, 13-16].
* *Examples:* Treasury Bills (T-Bills), Commercial Paper (CP), Interbank Deposits, Certificates of Deposit (CD), Repo [2, 12-15].
* **Capital Market Instruments (Medium- to Long-Term):** These securities have an original term to maturity of more than one year [14].
* **Notes (Intermediate-Term):** Generally considered to have a maturity between 5 and 12 years [5, 15].
* *Examples:* Medium-Term Notes (MTNs) [15, 17].
* **Bonds (Long-Term):** Typically have a maturity greater than 12 years [5, 15, 18, 19].
3. **Presence of Embedded Options**
* **Option-Free (Plain Vanilla):** The cash flows for these instruments are known with certainty, assuming no default [4, 20].
* **Instruments with Embedded Options:** These include various features that grant either the issuer or the bondholder the right, but not the obligation, to take a specific action, which can alter the instrument’s cash flows [4, 8, 20, 21].
* **Callable Bonds:** Can be prematurely retired by the issuing company [4, 8, 20, 21].
* **Putable Bonds:** Can be prematurely surrendered by bondholders in return for principal repayment [4, 8, 20, 22].
* **Convertible Bonds:** Can be converted into shares of stock by the investor [4, 15, 20, 23, 24].
* **Structured Notes:** Debt instruments that provide customized interest or principal payments dependent on the performance of a specified reference asset, market price, index, interest rate, or other market quantity. They combine a conventional note with an embedded derivative instrument, such as an option or a swap [17, 25-29]. They can offer principal protection or be non-principal protected [30].
* **Credit-Linked Notes (CLNs):** A specific type of structured note where the embedded derivative is a credit default swap (CDS) or another form of credit derivative [17, 28].
* *Example:* First-to-default CLN (linked to a basket of reference entities, with payment occurring upon the first default in the basket) [31, 32].
4. **Issuer Type and Collateralization**
* **Government/Sovereign Debt:** Issued by central, state, or local governments, often serving as a benchmark for other fixed income instruments [15, 16, 33-39].
* *Examples:* US Treasury securities (Treasury Bills, Notes, Bonds, STRIPS, Treasury Inflation-Protected Securities (TIPS)), German Bunds, Japanese Government Bonds [11, 24, 34, 37, 40, 41].
* **Corporate Bonds:** Issued by nonfinancial or financial corporations [12, 15, 16, 24, 36, 42, 43].
* *Examples:* Commercial Paper (CP), Medium-Term Notes (MTNs) [12, 17].
* **Municipal Bonds:** Issued by state and local governments [15, 16, 24].
* **Agency Bonds:** Issued by government agencies [15, 16].
* **Structured Products (Asset-Backed/Collateralized):** Debt instruments where cash flows are generated from and collateralized by an underlying pool of assets, rather than the general credit of a specific issuer [2, 15, 44-47].
* **Mortgage-Backed Securities (MBS):** Collateralized by mortgage loans [15, 42, 48-51].
* *Examples:* Residential MBS (RMBS), Commercial MBS (CMBS), Collateralized Mortgage Obligations (CMOs – which can include sequential pay CMOs and Planned Amortization Classes (PACs)), Stripped Mortgage-Backed Securities (SMBS) like Interest-Only (IO) and Principal-Only (PO) strips [15, 42, 46, 49, 50, 52-56].
* **Asset-Backed Securities (ABS):** Collateralized by financial assets other than residential mortgages [15, 42, 46].
* **Covered Bonds:** A debt instrument secured by a specific pool of collateral (collateral pool) but remains on the balance sheet of the issuer [2, 15, 46, 47].
5. **Hybrid Nature**
* **Preferred Stock:** This security exhibits characteristics of both debt and equity. Like debt, it often promises a fixed rate of return as a contractual obligation. However, like equity, these dividends are typically payable from post-tax profits, and preferred stock is often classified as equity on the balance sheet [15, 46, 57-61].
* **Fund-Linked Structured Products:** These products are specifically linked to the performance of various investment funds, such as mutual funds, Exchange-Traded Funds (ETFs), hedge funds, or managed accounts [62].
