Fixed Rate Bond
What Is a Fixed Rate Bond?
A fixed rate bond is a bond that pays similar level of interest over its whole term. An investor who needs to earn a guaranteed interest rate for a predefined term could purchase a fixed rate bond as a Treasury, corporate bond, municipal bond, or certificate of deposit (CD). On account of their consistent and level interest rate, these are referred to comprehensively as fixed-income securities.
Fixed rate bonds can be appeared differently in relation to floating or variable rate bonds.
Understanding Fixed Rate Bonds
A fixed rate bond is a long-term debt instrument that pays a fixed coupon rate however long the bond would last. The fixed rate is indicated in the trust indenture at the hour of issuance and is payable on specific dates until the bond develops. The benefit of claiming a fixed rate bond is that investors know with certainty how much interest they will earn and for how long. However long the bond issuer doesn't default or call in the bonds, the bondholder can anticipate precisely exact thing his return on investment will be.
A key risk of possessing fixed rate bonds is interest rate risk or the chance that bond interest rates will rise, making an investor's existing bonds less significant. For instance, we should expect an investor purchases a bond that pays a fixed rate of 5%, however interest rates in the economy increase to 7%. This means that new bonds are being issued at 7%, and the investor is done earning the best return on his investment as he could. Since there is an inverse relationship between bond prices and interest rates, the value of the investor's bond will fall to mirror the higher interest rate in the market. To sell his 5% bond to reinvest the proceeds in the new 7% bonds, he might do as such at a loss, on the grounds that the bond's market price would have fallen. The longer the fixed rate bond's term, the greater the risk that interest rates could rise and make the bond less important.
In the event that interest rates decline to 3%; notwithstanding, the investor's 5% bond would turn out to be more significant if he somehow happened to sell it, since a bond's market price increases when interest rates decline. The fixed rate on his bond in a declining interest rate environment will be a more alluring investment than the new bonds issued at 3%.
Different Considerations
An investor could reduce their interest rate risk by picking a shorter bond term. He would presumably earn a lower interest rate, however, on the grounds that a shorter-term fixed rate bond will typically pay under a longer-term fixed rate bond. In the event that a bondholder decides to hold his bond until maturity and doesn't sell it on the open market, he won't be worried about potential vacillations in interest rates.
The real value of a fixed rate bond is defenseless to loss due to inflation. Since the bonds are long-term securities, rising prices over the long haul can dissolve the purchasing power of each interest payment a bond makes. For instance, in the event that a ten-year bond pays $250 fixed coupons semi-every year, in five years, the real value of the $250 will be worthless today. At the point when investors worry that a bond's yield won't keep up with the rising costs of inflation, the price of the bond drops since there is less investor demand for it.
A fixed rate bond likewise conveys liquidity risk for those investors who are thinking about selling the bond before its maturity date. This risk happens when the spread between the bid price and ask price of the bond is too wide. On the off chance that this happens, and the bond holder is asking (ask price) for more than investors need to pay (bid price), then the original holder might be set in a scenario by which they sell the security for a loss or fundamentally reduced rate, consequently forfeiting liquidity.
Features
- Endless supply of the bond, holders will receive back the initial principal amount notwithstanding the interest paid.
- Typically, longer-term fixed-rate bonds pay higher interest rates that short-term ones.
- A fixed-rate bond is a debt instrument with a level interest rate over its whole term, with normal interest payments known as coupons.
