when the one year bond matures the 20 000 principal will be rolled into a bond maturing one year after the original three year holding when the second bond matures those funds roll into a bond that extends the ladder for another year and so on in this way the investor receives a constant flow of interest income and can take advantage of any higher interest rates 
fixed income investing is generally a conservative strategy where returns are generated from low risk securities that pay predictable interest example of fixed incomelet s say pepsico pep issues fixed rate bonds to fund a new bottling plant in argentina the issued 5 bond is available at a face value of 1 000 and is due to mature in five years the company plans to use proceeds from the new plant to repay the debt you purchase 10 bonds costing a total of 10 000 and will receive 500 in interest payments each year for five years 0 05 x 10 000 500 the company receives the 10 000 and uses the funds to build the overseas plant the interest amount is fixed and gives you a steady income upon maturity in five years the company pays you back the principal amount of 10 000 you earn a total of 2 500 in interest over the five years 500 x five years advantages and disadvantages of fixed incomeincome generationfixed income investments offer investors a steady stream of income over the life of the bond or debt instrument they offer the issuer much needed access to capital or money steady income lets investors plan their spending a reason these are popular products in retirement portfolios relatively less volatilethe interest payments from fixed income products can also help investors stabilize the risk return in their investment portfolio known as the market risk for investors holding stocks fluctuating prices can result in large gains or losses the steady and stable interest payments from fixed income products can partly offset losses from the decline in stock prices as a result these safer investments help to diversify the risk of an investment portfolio guaranteesfixed income investments in the form of treasury bonds have the backing of the u s government 8corporate bonds while not insured are backed by the financial viability of the underlying company should a company declare bankruptcy or liquidation bondholders have a higher claim on company assets than do common shareholders 9moreover bond investments held at brokerage firms are backed by the securities investor protection corporation sipc with up to 500 000 coverage for cash and securities fixed income cds have federal deposit insurance corporation fdic protection up to 250 000 per individual 6fixed rates are great for lower risk but once you ve locked in a rate you can t increase it during inflationary periods fixed income securities are less favorable because newly issued bonds will have higher rates of return although there are many benefits to fixed income products as with all investments there are risks that investors should be aware of before purchasing them credit and default riskas mentioned earlier treasuries and cds have protection through the government and fdic 6 when choosing a corporate bond investment look at the credit rating of the bond and the underlying company to size up the risk of default bonds with ratings below bbb are of low quality meaning your risk of loss is higher and are considered junk bonds 10the credit risk linked to a corporation can have varying effects on the valuations of the fixed income instrument leading up to its maturity for example if a company is struggling financially the prices of its bonds on the secondary market might decline in value if an investor tries to sell a bond of a struggling company the bond might sell for less than the face or par value also liquidity could be an issue that is the bond may become difficult for investors to sell in the open market at a fair price or at all because there s no demand for it the prices of bonds can increase and decrease over the life of the bond if the investor holds the bond until its maturity the price movements are immaterial since the investor will be paid the face value of the bond upon maturity however if the bondholder sells the bond before its maturity through a broker or financial institution the investor will receive the current market price at the time of the sale the selling price could result in a gain or loss on the investment depending on the underlying corporation the coupon interest rate and the current market interest rate interest rate riskfixed income investors might face interest rate risk this is the risk that in an environment where market interest rates are rising the rate paid by the bond falls behind and in such a case the bond would lose value in the secondary bond market with bonds when rates rise prices fall also the investor s capital is tied up in the investment and they cannot put it to work earning higher income without taking an initial loss for example if an investor purchased a two year bond paying 2 5 per year and interest rates for 2 year bonds jumped to 5 the investor is locked in at 2 5 for better or worse investors holding fixed income products receive their fixed rate regardless of where interest rates move in the market inflationary riskinflationary risk is also a danger to fixed income investors the pace at which prices rise in the economy is called inflation if inflation increases it eats into the gains of fixed income securities for example if fixed rate debt security pays a 2 return and inflation rises by 1 5 the investor loses out earning only a 0 5 return in real terms steady income stream of fixed returnsmore stable returns than stockshigher claim to the assets in bankruptciesgovernment and fdic backing on somereturns are often lower than other investmentscredit and default risk exposuresusceptible to interest rate risksensitive to inflationary risk