Fixed Rate Bonds

Updated on January 5, 2024
Article bySusmita Pathak
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

Fixed Rate Bonds Definition

Fixed rate bonds (FRBs) refer to debt securities, offering regular and fixed interest or coupon payments until their maturity. The interest rate and the expiration date are agreed upon between the issuer and the investor. As a result, FRBs pay a higher interest rate than the rest of the investment accounts.

These bonds are appropriate for investors who do not wish to withdraw invested funds in the middle of the term or are looking for guaranteed returns on investments. Since yields are available at a fixed rate, these bonds are also considered fixed-income securities. Governments, private corporations, and other entities issue these bonds to raise funds for their operations.

Fixed Rate Bonds

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Key Takeaways

  • Fixed rate bonds (FRBs) are debt securities that pay a fixed interest rate or a coupon until they mature. The issuer and the investor agree on the interest rate and the expiration date.
  • These bonds come in various maturities, including short-term and long-term, and have a lock-in term of one to five years.
  • Investors receive their initial principle back from the issuer when a bond matures, along with interest payments made monthly, semi-annually, or annually.
  • Examples of FRBs are certificates of deposits (CDs), treasury bills, treasury bonds, corporate bonds, asset-backed securities, municipal bonds, and preferred stocks.

Understanding Fixed Rate Bonds

Fixed rate bonds or securities provide investors with consistent and assured interest or coupon payments on investments over their maturity. People prefer investing in these bonds as the rates remain unaffected by even the worst market fluctuations. The coupon payments or preferred dividendsPreferred DividendsPreferred dividends refer to the amount of dividends payable on preferred stock from profits earned by the company, and preferred stockholders have priority in receiving such dividends over common stockholders.read more depend on the borrower’s creditworthinessCreditworthinessCreditworthiness is a measure of judging the loan repayment history of borrowers to ascertain their worth as a debtor who should be extended a future credit or not. For instance, a defaulter’s creditworthiness is not very promising, so the lenders may avoid such a debtor out of the fear of losing their money. Creditworthiness applies to people, sovereign states, securities, and other entities whereby the creditors will analyze your creditworthiness before getting a new loan.read more and existing interest rates. In addition, investors can invest in fixed-rate securities to diversify their portfoliosDiversify Their PortfoliosPortfolio diversification refers to the practice of investing in a different assets in order to maximize returns while minimizing risk. This way, the risk is kept to a minimal while the investor accumulates many assets. Investment diversification leads to a healthy portfolio.read more. Furthermore, they protect the deposited amount.

Fixed Rate Bonds Advantages

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These bondsBondsBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period.read more are available with both short-term and long-term maturity. The lock-in period of fixed-income securities ranges from one to five years. Once investors invest in fixed rate securities, they cannot withdraw anything until the term expires or the amount matures. If they still do so, they are liable to pay a significant penalty.

At bond maturity, investors get their initial principal amount (or face value) back along with interest payments from the issuer. The fixed payment of interests can be monthly, semi-annually, or annually. Then, bondholders can withdraw, transfer, or reinvest those funds in access or another account, depending on the issuer.

Unlike floating or variable rate bonds, FRBs remain fixed and do not move up or down with the market or index. Hence, investors get the expected returns at the end of the tenure. As a result, these securities are suitable for those with a good understanding of investment-related risks.

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Most of the bonds available in the market fall under the fixed-rate securities category, such as certificates of depositsCertificates Of DepositsA certificate of deposit (CD) is an investment instrument mostly issued by banks, requiring investors to lock in funds for a fixed term to earn high returns. CDs essentially require investors to set aside their savings and leave them untouched for a fixed period.read more (CD), treasury billsTreasury BillsTreasury Bills (T-Bills) are investment vehicles that allow investors to lend money to the government.read more, treasury notesTreasury NotesTreasury Notes are government-issued instruments with a fixed rate of interest and maturity date. As a result, it is the most preferred option because it is issued by the government (therefore, there is no risk of default) and also gives a guaranteed amount as a return, allowing the investor to plan accordingly.read more, treasury bondsTreasury BondsA Treasury Bond (or T-bond) is a government debt security with a fixed rate of return and relatively low risk, as issued by the US government. You can buy treasury bonds directly from the US Treasury or through a bank, broker, or mutual fund company.read more, corporate bondsCorporate BondsCorporate Bonds are fixed-income securities issued by companies that promise periodic fixed payments. These fixed payments are broken down into two parts: the coupon and the notional or face value.read more, asset-backed securitiesAsset-backed SecuritiesAsset-backed Securities (ABS) is an umbrella term used to refer to a kind of security that derives its value from a pool of assets, such as bonds, home loans, car loans, or even credit card payments.read more, municipal bondsMunicipal BondsA municipal bond is a debt security issued by a national, state, or local authority to finance capital expenditures on public projects related to the development and maintenance of infrastructures such as roads, railways, schools, hospitals, and airports.read more, preferred stocksPreferred StocksA preferred share is a share that enjoys priority in receiving dividends compared to common stock. The dividend rate can be fixed or floating depending upon the terms of the issue. Also, preferred stockholders generally do not enjoy voting rights. However, their claims are discharged before the shares of common stockholders at the time of liquidation.read more, etc.

Fixed-Rate Bond Risks

Fixed-rate securities offer a higher interest rate and better returns than easy access savings accounts. However, they come with a certain element of risks, such as:

  • The longer the maturity period, the higher the interest rate, which results in significant yields but lowers the instrument value.
  • With shorter maturity and lower interest rates, FRBs generate lower returns and pose lower investment risks.
  • Inflation can greatly affect the value of fixed rate securities and purchasing power of coupon payments.
  • Investors may face liquidityLiquidityLiquidity is the ease of converting assets or securities into cash.read more issues as the put-call spread widens.

Fixed Rate Bonds Examples

Let us look at the following fixed rate bonds examples to get a better understanding of the concept:

Example #1

Cyrus decided to invest in two financial instrumentsFinancial InstrumentsFinancial instruments are certain contracts or documents that act as financial assets such as debentures and bonds, receivables, cash deposits, bank balances, swaps, cap, futures, shares, bills of exchange, forwards, FRA or forward rate agreement, etc. to one organization and as a liability to another organization and are solely taken into use for trading purposes.read more for two years – an easy access savings account and a fixed rate bond. Both of them were available to the holder at 4%. While the former was subject to market favorability, the latter had a fixed coupon rate resistant to market fluctuations. 

As a result, Cyrus could plan his financial expenses with sure-shot returns on the fixed rate securities after two years. But he could not plan anything due to the uncertainties related to the easy access savings account.

Example #2

Fixed-income securities have appeared to be one of the best financial vehicles to invest in, given recent market fluctuations and the possibility of inflation throughout the world. FRBs are inflation-protected securitiesInflation-protected SecuritiesTreasury inflation-protected securities (TIPS) are inflation-indexed bonds issued by the US government. Since its principal is indexed to the US consumer price index, it provides a hedge to the inflation risk. With increasing inflation, TIPS's principal values also rise, hedging the bond's inflation risk.read more because their rates are fixed and unaffected by market conditions.

Recently, American Century has attempted to introduce a short-term, high-yield financial instrument via its new Multisector Income ETF. The company intends to make investments easier and rewarding for those who want a precise estimate of the long-term returns they could expect.

Example #3

Fixed rate bonds UK come with options for children with no minimum age limit. Plus, individuals without a current account can also open a “Re: Account” on behalf of someone else.

Banks and other financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more offer several fixed rate accounts in the UK. These investments remain protected by the Financial Service Compensation Scheme (FSCS). It provides coverage to up to £85,000 in savings at each financial institution. As a result, investors remain confident about getting their money back even if the institution fails to pay them.

Pros And Cons

Though a fixed rate bond offers several advantages over its alternatives, a few drawbacks lead some people to choose other options. In a nutshell, here are the benefits and disadvantages of these bonds:

ProsCons
Fixed income through couponsNo withdrawal allowed before maturity
Resistant to market changesPenalty for early withdrawal
Better interest rates than a protected savings accountLack of flexibility
Exact returns are already known to bondholdersThe risk of increased interest rates as a result of inflation, reducing the value of bonds

Frequently Asked Question (FAQs)

What are fixed rate bonds?

Fixed rate securities or bonds are investment vehicles that pay regular and fixed coupon payments agreed upon until maturity. They are designed for investors who do not want their returns influenced by interest rate fluctuations due to market conditions. These bonds can be short- or long-term, have a lock-in term of one to five years, and have a higher interest rate as the term lengthens.

Can you lose money on a fixed rate bond?

Investors of fixed-income securities or bonds will lose funds only if they withdraw before the investment term expires or the amount matures. However, they will be subject to a substantial penalty in doing so.

What are the benefits of investing in fixed rate bonds?

The benefits of the fixed rate bonds are as follows:
– It offers a steady and set defined income through coupon payments.
– The amount and interest rate remain resistant to market changes.
– It offers higher interest rates than other easy-access savings account.
– It helps investors know the exact returns in advance.

This has been a guide to what are Fixed Rate Bonds and its definition. Here we discuss how fixed rate bonds work, along with its risks and examples. You may learn more about financing from the following articles –

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