A fixed-rate bond is a debt security that pays a predetermined, constant interest rate over its life and returns the principal at maturity.
A fixed-rate bond is a type of bond where the interest payments, known as coupons, are set at a fixed rate for the duration of the bond's life. This means the bondholder receives consistent periodic interest income until the bond matures. At maturity, the issuer repays the bond’s face value or principal to the investor. Fixed-rate bonds are commonly issued by corporations, governments, and other entities to raise capital. Investors value these securities for the predictability of their income streams and relative stability in returns compared to variable-rate bonds.
Fixed-rate bonds are important in wealth management and family office strategies because they offer predictable cash flows, which are essential for income planning and liability matching. Their fixed interest payments allow portfolio managers to better forecast income and manage risk associated with fluctuating interest rates. In tax planning, the knowledge of exact coupon amounts helps to estimate taxable income accurately. From a governance perspective, including fixed-rate bonds in a diversified portfolio can reduce overall volatility and safeguard capital, providing a stabilizing effect against equity market swings.
Consider a fixed-rate bond with a face value of $100,000, a 5% annual coupon rate, and a 10-year maturity. The investor will receive $5,000 each year in interest payments for 10 years and the $100,000 principal at the end of the 10th year. The total interest received over the bond’s life will be $50,000, plus repayment of the initial investment.
Variable Rate Bond
Unlike fixed-rate bonds, variable rate bonds have interest payments that fluctuate based on a benchmark interest rate or index, which can lead to varying income levels and risk exposure over time. Fixed-rate bonds provide stable income, whereas variable rate bonds offer protection against rising interest rates but generally have less predictable cash flows.
What happens to the value of a fixed-rate bond if interest rates rise?
When interest rates rise, the market value of fixed-rate bonds typically falls because their fixed coupon payments become less attractive compared to new bonds issued at higher rates. However, holding the bond to maturity guarantees repayment of principal and fixed coupons regardless of market price fluctuations.
Are fixed-rate bonds suitable for all investment horizons?
Fixed-rate bonds can be suitable for various investment horizons, but their interest rate risk means that longer-term bonds are generally more sensitive to interest rate changes. Investors with shorter horizons may prefer shorter maturities or consider potential price fluctuations if they plan to sell before maturity.
How do fixed-rate bonds compare to floating-rate bonds in terms of income stability?
Fixed-rate bonds offer stable and predictable income due to their constant coupon payments, whereas floating-rate bonds provide variable income that adjusts with benchmark rates. Fixed-rate bonds appeal to investors seeking certainty, while floating-rate bonds may better hedge against rising interest rates.
