1. Fixed Income Fundamentals of Inve$ting
Garcia Hamilton & Associates
Presented By:
Jeffrey D. Detwiler, CFA, AAMS
Partner/Portfolio Manager
Fixed Income Fundamentals of Inve$ting
5 Houston Center
1401 McKinney, Suite 1600
Houston, TX 77010
Tel: (713)
Fax: (713)
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2. Fixed Income Basics Interest Rate Risk Credit Risk Market Environment
Table of Contents
Fixed Income Basics
Interest Rate Risk
Credit Risk
Market Environment
Conclusion

3. What are Bonds? Bonds 101: What are bonds and why do they exist?
A bond is a debt security, similar to an I.O.U.
When you purchase a bond, you are lending money to an issuer.
In return for that money, the issuer provides you with a promise to pay a specified rate of interest during the life of the bond and to repay the principal when it comes due.
Sources: US Bond Market Outstanding:

4. Types of Bonds Corporate Securitized Treasury Agency
Sources: istockphoto/RichardCano,

5. Types of Bonds 1976 2018 $456 Billion $20.3 Trillion
Source: Bloomberg Barclays Live
Chart Data as of 12/31/80 and 9/30/18
Bloomberg Barclays U.S. Aggregate Index

6. Coupon: Features: Coupon
A feature of a bond that denotes the amount of interest due, and the date payment will be made.
A bond is normally an interest-only loan, meaning the borrower pays the interest every period, but none of the principal is repaid until the end of the loan.
Source:

7. Maturity: Features: Maturity
The date when the principal amount of a security is due to be repaid.
Generally, bond terms range from one year to 30 years.
Short-term bonds generally offer lower yields.
Long-term bonds generally offer higher yields.
Source:

8. Rating: Features: Rating
Designations used by credit rating agencies to give relative indications as to opinions of credit quality.
Generally speaking, a higher rating means less risk but a lower potential return and vise-versa.
Source:

9. Understanding Risks
All investments carry some degree of risk, which is linked to the return that investment will provide.
A good rule of thumb is the higher the risk, the higher the return.
Two types of Risk related to fixed income:
Interest Rate Risk
Credit Risk
Conversely, safer investments offer lower returns. There are a number of key variables that comprise the risk profile of a bond: its price, interest rate, yield, maturity, redemption features, default history, credit ratings and tax status. Together, these factors help determine the value of your bond investment and whether it is an appropriate investment for you.

10. Interest Rate Risk
Interest rates and bond prices are like a see-saw – when interest rates rise, bond prices fall (and vice versa).
How much interest risk a bond has depends on how sensitive its price is to interest rate changes.
Duration is a measure of the sensitivity of price change to interest rate changes.

11. Interest Rate Risk Duration Example Duration Portfolio A 5 Portfolio B2
Interest rates, in general, RISE by 100 BPS (1.0%). 
Which portfolio LOSES value the most?
Portfolio A would lose approximately 5%
Portfolio B would lose approximately 2%
Interest rates, in general, FALL by 100 BPS (1.0%). 
Which portfolio GAINS value the most?
Portfolio A would gain approximately 5%
Portfolio B would gain approximately 2%
Dates and data used are for illustration purposes only and may not reflect actual data as of the dates shown.

12. Less Interest Rate Risk More Interest Rate Risk HIGHER LOWER SHORTER
LONGER
HIGHER
SHORTER
If the Coupon Rate is
If the Maturity
Source:

13. Credit Risk
The risk that a borrower will default on any type of debt by failing to make payments which it is obligated to do.  
Credit risks are calculated based on the borrower’s overall ability
to repay.
Ratings agencies such as S&P, Moody's, and Fitch evaluate the credit risks of thousands of issuers on an ongoing basis.
Conversely, safer investments offer lower returns. There are a number of key variables that comprise the risk profile of a bond: its price, interest rate, yield, maturity, redemption features, default history, credit ratings and tax status. Together, these factors help determine the value of your bond investment and whether it is an appropriate investment for you.

14. Credit Risk Why quality matters…
A bond’s yield is calculated assuming that all the promised payments will be made.
As a result, it is really a promised yield, and it may or may not be what you will earn.
If the issuer does not make the promise payment, your actual yield will be much lower.
Conversely, safer investments offer lower returns. There are a number of key variables that comprise the risk profile of a bond: its price, interest rate, yield, maturity, redemption features, default history, credit ratings and tax status. Together, these factors help determine the value of your bond investment and whether it is an appropriate investment for you.
Source:

15. Credit Ratings* Strongest Weakest MOODY’s STANDARD & POOR’S
DESCRIPTION
INVESTMENT GRADE
Strongest
Aaa
AAA
Highest Rating Aa AA
Very Strong A
Upper Medium Grade
Baa
BBB
Lower Medium Grade
NON-INVESTMENT GRADE
Weakest Ba BB
Non-Investment Grade B
Highly Speculative
CCC
Caa
Substantial Risk CC Ca C D
Issuer is in Default
*These credit ratings are reflective of obligations with long-term maturities.
Conversely, safer investments offer lower returns. There are a number of key variables that comprise the risk profile of a bond: its price, interest rate, yield, maturity, redemption features, default history, credit ratings and tax status. Together, these factors help determine the value of your bond investment and whether it is an appropriate investment for you.
Source:

16. Credit Risk 1980 2018 $178 Billion $5.1 Trillion
Source: Bloomberg Barclays Live
Chart Data as of 12/31/80 and 9/30/18
Bloomberg Barclays U.S. Corporate Index

17. Credit Spreads AAA AA A BBB Ratings Examples % of Index*
Microsoft, Johnson & Johnson
1.9% AA
Berkshire Hathaway, Apple, Wal-Mart
8.4% A
JP Morgan, Wells Fargo, Pepsi, Pfizer
40.6%
BBB
AT&T, Xerox, McDonalds, General Electric
49.1%
*Percentage of Bloomberg Barclays Investment Grade Corporate Index
Source: Bloomberg, Barclays Live
Last Update: 9/30/2018
**Option Adjusted Spread

18. Market Environment
The Federal Reserve has begun the process of Monetary Policy “Normalization”
As a result the yield curve has “Flattened”
Corporate bond spreads have recovered to “pre-crisis” levels

19. Yield Curve Changes Dec 2013 Sept 2018
3m 6m 2yr yr yr yr
Dec 2013
Sept 2018
US Treasury Actives Curve 12/31/2013
US Treasury Actives Curve 9/30/2018
12/31/13
9/30/18
Difference
3 Month
0.07
2.19
2.12
6 Month
0.09
2.36
2.27
2 Year
0.38
2.82
2.44
5 Year
1.74
2.95
1.21
10 Year
3.03
3.06
0.03
30 Year
3.97
3.20
-0.77
Source: Bloomberg
Last Update: 9/30/2018

20. Average Option Adjusted Spreads (OAS)
U.S. Credit Downgrade
Greece
Gulf War
MW 5/18/2018 -LEAVE END OF MONTH CHART AS BACKUP. **REMOVE ALL MID MONTH DATA WHEN END OF MONTH NUMBERS ARE AVAILABLE.
Source: Barclays Live
Last Update 9/30/2018

21. Conclusions
It is important to understand how both interest rate risk and credit risk might impact your portfolio.
The importance of having an investment manager who can successfully navigate both types of risks has risen as the market dynamics have changed.
Looking forward, expect short term rates to continue to gradually move higher as the Fed continues on the path of monetary policy “normalization”
Conversely, safer investments offer lower returns. There are a number of key variables that comprise the risk profile of a bond: its price, interest rate, yield, maturity, redemption features, default history, credit ratings and tax status. Together, these factors help determine the value of your bond investment and whether it is an appropriate investment for you.