Fixed Income

Fixed income refers to a broad category of financial instruments that provide regular interest payments, known as coupons, over a set period of time. At the end of this period, the issuer returns the original amount borrowed, known as the principal or face value. Unlike equity instruments, which represent a claim on a company's assets and earnings after debt holders and whose returns reflect a mix of company-specific and market-wide factors, fixed income instruments are contractual debt agreements: the investor lends money to the issuer and receives coupon payments in return. The most common types include government bonds (of which short-dated forms such as treasury bills are one example), corporate bonds, and other debt instruments.

The relationship between bond prices and interest rates is inverse and mathematical. When prevailing interest rates rise, the prices of existing bonds fall, because their fixed coupons are worth less relative to the higher coupons available on newly issued bonds. When rates fall, existing bond prices rise. The yield of a bond, the effective return earned by a holder at its current market price, captures this relationship. Suppose a €10,000 face-value bond pays a 5% annual coupon, that is €500 per year, and is purchased at face value; its yield is 5%. If market rates rise and the bond's price falls to €9,500, the yield rises to approximately 5.26%, even though the €500 coupon itself has not changed.

Bond markets serve a fundamental role in the financial system, providing governments and corporations with access to long-term capital. Yields on government bonds are closely watched as indicators of broader economic conditions: rising yields may signal expectations of stronger growth or higher inflation, while falling yields can reflect concerns about slowing growth or demand for safer assets. Corporate bond yields typically trade above government yields by a credit spread that compensates investors for default risk, so bonds from issuers with weaker credit quality tend to offer higher yields. Within a given issuer, liquidity is usually concentrated in the most recently issued bonds, known as on-the-run bonds, which trade more actively and at tighter spreads than older, off-the-run issues of similar maturity.

For market makers, fixed income presents distinct challenges compared with equities. Bond markets are largely traded over the counter, with liquidity concentrated in recently issued bonds and declining in older issues. Interest rate movements affect not only fixed income positions directly but also the valuation of equities, options, and ETFs that Optiver holds across all its trading channels. Managing fixed income risk therefore requires integrating bond market dynamics with the broader portfolio. Optiver provides liquidity in fixed income instruments across its electronic trading and direct counterparty channels.

Suppose a market maker is providing a two-way quote for a 10-year government bond with a face value of €1 million, paying a 3% annual coupon. If prevailing yields are 3%, the bond trades close to face value. An unexpected central bank rate increase of 0.5% then causes yields on comparable bonds to rise to 3.5%, and the bond's market price falls to approximately €960,000. When hedging costs and adverse-selection risk rise, the market maker may widen its bid-ask spread. An investor holding the bond now faces a paper loss of around €40,000.

For more on how market participants manage exposure to interest rate and price movements, see our explainer on Hedging.