Fixed income securities

A fixed income security is a financial obligation in which the issuer of the security agrees to pay a specified amount to the holder of the security at specified future dates. Debt obligation, such as bonds, and preferred stock are the two most common types of fixed income securities. The holders of debt obligations are called lenders or creditors, while issuers of debt securities are called borrowers. The holders of preferred stocks are called preferred stock holders.

The payments that are made on debt obligations are interest and principal repayments; preferred stocks pay dividends. Under most circumstances, the failure to pay interest or principal repayments on debt obligations in a timely manner is an act of default. However, preferred stockholders, as equity investors in a company, are entitled to preferred dividends only if they are declared by the issuers board of directors. Preferred stockholders have the right to dividends ahead of common shareholders. They also have a prior claim on funds resulting from a company’s liquidation that comes ahead of common shareholders.

The contract between the issuer of bonds and the bondholders that sets forth the obligations of the borrower and the rights of the lender is called an indenture. However, a trustee is interposed between the issuer and the bondholders. The trustee is a fiduciary who is charged with the duty of representing the bondholders, making sure the issuer meets its obligations and the bondholders rights are upheld. It is the trustee who can send an issuer into default if it fails to honor the bondholders rights. It is the trustee who can send an issuer into default if it fails to meet all of its obligations as set forth in the indenture.