Fixed rate bonds have a specific interest rate for the life of the bond, unlike floating rate bonds. Conservative investors prefer fixed-rate bonds as they offer a predictable return, whereas some investors prefer floating rate bonds for the potential of higher returns. Issuers also prefer fixed-rate bonds as it is easier to calculate interest payments. The decision to invest in fixed rate bonds depends on personal preference and market indicators.
Fixed rate bonds are bonds that are issued with a specific interest rate that applies for the life of the bond. This is in contrast to a floating rate bond, where the interest rate fluctuates based on the current average interest rate. The interest rate, known as the coupon rate, may be paid at specified intervals over the life of the bond, or it may be provided in a lump sum when the bond reaches full maturity.
For some investors, fixed-rate bonds are decidedly better options than going with floating-rate notes. More conservative investors who want to know exactly what the rate of return on their investment will often prefer the fixed-rate coupon, since it is easier to plan what to do with the return when it is received. Going with the fixed rate also means that the investor does not have to worry about sudden or drastic changes in the economy that could have an adverse effect on interest rates and therefore minimize the projected return of a floating rate bond. .
Some issuers also prefer fixed-rate bonds, simply because it is easier to calculate how much interest will be paid to investors over the life of the bond. This benefit can be especially important for municipalities that issue bonds as a means of financing improvements to municipal property, such as paving streets or renovating city- or town-owned buildings. Since taxes are often the source of revenue used to pay the bond amount plus applicable interest, the flat rate helps planners determine the amount of additional taxes that are necessary to adequately finance the project.
Other investors find that fixed-rate bonds are not to their liking, simply because there is no opportunity to increase the yield on the bond issue. For this reason, some of these investors are willing to take on the additional risk associated with a variable rate, especially if their research indicates that the average interest rate is likely to rise and remain elevated for most of the life of the interest rate. bond. . While there is always the possibility that projections may not turn out to be accurate, the prospect of higher returns is attractive enough to have the opportunity to earn that higher return.
The decision to invest in fixed rate bonds is a personal one. While the fixed rate approach is safer for the investor, the floating rate offers the potential for higher returns. Investors should closely watch market indicators and project whether the interest rate is likely to rise over the life of the loan, and stay at higher levels long enough for the yield to be higher than going with the fixed rate. Once that projection is available, it is much easier to determine what type of bond rate is likely to be in the best interest of the investor.
Smart Asset.
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