Fixed Deposits are one of the most innovative and dynamic instruments that have evolved in the financial system ever since the inception of money. As they are based on the concept of interest and the time value of money, fixed deposits personify the essence of innovation and transformation, which have fueled the explosive growth of the financial markets over the past few centuries.
Fixed Deposits serve as a medium of saving and payment and are a significant variable in the national economy.
Types of Fixed Deposits
Bank Fixed Deposits
Time deposits, also known as bank fixed deposits are deposit schemes offered by banks where an amount is deposited for a fixed period, say 365 days, two years, or five years. Some term deposits of an extended period, i.e., five years fixed deposit, offer tax benefits on the initial investment. A term deposit could be cumulative or non-cumulative based on interest payment. If interest is paid periodically, say every month, half-yearly, or yearly, it would be termed a non-cumulative fixed deposit. In contrast, if interest is not paid but accumulated over the period for which a fixed deposit is created and paid on maturity, it is termed a cumulative fixed deposit.
Corporate Fixed Deposit
Corporate and NBFCs also offer Fixed Deposits. The amount of deposits NBFCs and corporates may raise is linked to their net worth and credit rating. The fixed deposits provided by corporates and NBFCs are not insured, whereas the deposits accepted by most banks are insured up to a maximum of Rs.5 Lakhs.
Coupon bonds typically pay interest periodically at the pre-specified rate of interest. The annual rate at which the interest is paid is known as the coupon rate or simply the coupon. Interest is usually paid every half-year though some bonds pay interest monthly, quarterly, annually, or at some other frequency. The dates on which the interest payments are made are known as the coupon due dates.
Mortgage-backed bond is a collateralized debt security. A pledged collateral backs every issue of such bonds. Collateral will be a property that can be pledged as a security. The bonds could be secured by a first or second charge on the pledged collateral. This ensures that bonds would be given preference in repayment in the event of company liquidation. However, first, charge bonds would get priority over second-charge bonds. The terms of these bonds are like any other bonds in the market, with semi-annual or quarterly payments of interest and final bullet payment of principal.
What are the Features of Fixed Products?
Fixed income instruments typically include company bonds, fixed deposits, and government securities. Some of the important reasons for investing in fixed income products are :
- Predictable Returns,
- Short-Term Investments,
- Capital Protection,
- Regular Income,
- Suitable for Investors with low-risk tolerance.
Returns from fixed income instruments are predictable; i.e., they offer a fixed rate of return. In comparison, returns from shares are uncertain. Therefore, fixed-income instruments are recommended if one needs a specific, predictable income stream.
Short Term Investments
Fixed income products are suitable for investors with a short duration horizon, i.e., they need money after a short period, say one year or a maximum of five years. This is because investments in fixed-income products do not appreciate value but provide an income stream at a defined frequency. At the same time, equity investments should be made with a long-term view. This is because equity investments are volatile and may not perform well in the short term.
Fixed income products provide capital protection. Amount invested in fixed income products does not fluctuate in value nor provides capital appreciation. Fixed income products issued by banks and NBFCs are not traded in the secondary markets and are not subject to price fluctuation due to changing interest rates. Whereas bonds and debentures issued by corporates, PSUs, and other eligible institutions could be suitable for trading in the secondary market and are subject to price fluctuations due to changing interest rates, for example; a bond issued by a company one year ago at face value of Rs 1,000 @8% p.a. might be trading on a premium due to decrease in current interest rate, say @ Rs 1,050 or Rs 1,100. Change in market value would be based on changes in interest rate. A lower interest rate will increase the market value of earlier issued bonds and vice-versa. This is due to yield adjustment.
A unique feature of fixed income products is that they provide interest on a regular pr-defined monthly or yearly frequency. Interest is provided at a stated rate, also called coupon rate in bond investments. Interest is always provided on the face value of the deposit. For example: if a market value of a corporate bond is Rs 1100 and its face value is Rs 1,000 with an 8% coupon rate, then the company will provide interest of @8% p.a. on face value, i.e., 8% on Rs Rs 1,000 and not on Rs,1100. The amount of interest would be Rs 80/- per anum (8%*Rs 1,000).
One of the key benefits of fixed income instruments is low risk, i.e., the relative safety of the principal and a predictable rate of return (yield). If one’s risk tolerance level is low, fixed-income investments might suit the investment needs better. But it should be remembered that these still have associated risks like default risk, i.e., the company may default on interest and principal repayment on maturity.
What Should Investors Check before investing in Fixed Income Deposits?
Before deciding to invest in fixed income instruments, an investor should evaluate their needs, financial goals, and features of fixed income products, like:-
- Liquidity; i.e., is the fixed income scheme liquid or has a lock-in period? For example, a lock-in period in tax saving bank FD wouldn’t allow early redemption even if there is a dire need for money.
- Interest Rate: is the issuing entity, i.e., bank, NBFC, or corporate, providing returns comparable with other products in the market? Any scheme or product giving a higher return should b looked at with caution. Usually, corporates and financial institutions offer higher interest rates when their credit rating is not high.
- Rating: Banks do not require rating by credit rating agencies. Corporates and NBFCs need ratings from credit rating agencies. Investors should choose high-grade deposits with high credit ratings, like AA, AA+, and AAA. Further, fixed income deposits offered by scheduled commercial banks, private and public, are safe.
Conclusion: Fixed Deposits are a Preferred Asset Class
They are an essential component of any portfolio of financial assets, whether in pure interest-bearing bonds, innovative and varied types of debt instruments, or some structured deposit instruments. Fixed income securities offer preferred features like; safety of investments, liquidity, easy monitoring, long-term reliability, and predictable returns.