Fixed rate bond
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In finance, a fixed rate bond is a type of debt instrument bond with a fixed coupon (interest) rate, as opposed to a floating rate note. A fixed rate bond is a long term debt paper that carries a predetermined interest rate. The interest rate is known as coupon rate and interest is payable at specified dates before bond maturity. Due to the fixed coupon, the market value of a fixed-rate bond is susceptible to fluctuations in interest rates, and therefore has a significant amount of interest rate risk. That being said, the fixed-rate bond, although a conservative investment, is highly susceptible to a loss in value due to inflation. The fixed-rate bond’s long maturity schedule and predetermined coupon rate offers an investor a solidified return, while leaving the individual exposed to a rise in the consumer price index and overall decrease in their purchasing power.
The coupon rate attached to the fixed-rate bond is payable at specified dates before the bond reaches maturity; the coupon rate and the fixed-payments are delivered periodically to the investor at a percentage rate of the bond’s face value. Due to a fixed-rate bond’s lengthy maturity date, these payments are typically small and as stated before are not tied into interest rates.
Difference between Fixed and Floating rate bonds
Unlike a fixed-rate bond, a floating rate note is a type of bond that contains a variable coupon that is equal to a money market reference rate, or a federal funds rate plus a specified spread. Although the spread remains constant, the majority of floating rate notes contains quarterly coupons that pay-out interest every 3 months with variable percentage returns. At the beginning of each coupon period, the rate is calculated by adding the spread with the reference rate. This structure differs from the fixed-bond rate which locks in a coupon rate and delivers it to the holder semi-annually over a course of multiple years.
Do they provide better returns?
Bonds generally provide higher rates of interest than other bank accounts, so fixed rate bond accounts are ideal for people who have spare money that they can afford to lock away for a fixed period of time.
There are a number of factors that you need to be aware of before choosing your account, for example, some accounts offer interest that it adds onto your balance monthly, which then accumulates more interest throughout the year based on the total balance. Other accounts pay the interest owed when the term ends, or pay the interest into a separate savings account on a monthly basis, so you will only be paid interest on the opening balance.
Purchasing a fixed rate bond is knowing, from the very start, what to expect out of the investment. As such, beginners in the investment world, as well as more experienced but conservative ones see this as a good and stable option. Those who are not very well-versed in investments could benefit, because it would no longer becomes necessary to monitor each change in the economy that might have a detrimental effect to the expected return of the bond.
Some fixed rate bonds allow for the issuer to repay the principal amount earlier than the contractual repayment date, sometimes on payment of a specified penalty or "make whole" payment. The provisions specifying such a penalty are known (particularly in the UK) as a spens clause.
Fixed rate of interest - Regardless of how the official Bank interest rate moves over the term of the bond its interest rate stays fixed until the bond expires.