What is Fixed Rate Bond? | Can bonds lose money and value?

WHAT IS A FIXED RATE BOND?

If investors are having a sum of money that they do not need for emergencies or living expenses, they may want to consider investing it s a lump sum in a Fixed Rate Bond which is a type of debt instrument that offers a fixed rate of interest for a fixed tenure. In this article, we will walk you through what a Fixed Rate Bond is, how it works, and other significant aspects of the same. 

WHAT IS A FIXED RATE BOND?

A fixed-rate bond can be described as a debt instrument that has a fixed rate of return throughout its tenure. This is why it is often referred to as a fixed income instrument. The best-fixed rate bonds serve as a type of savings account that offers a higher return or coupon rate. 

It is often seen investors getting confused between this and floating/variable-rate bonds. The fixed rate is mentioned in the trust indenture during purchase and has to be paid on pre-fixed dates till the time the bond matures. 

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WORKING OF FIXED-RATE BONDS

This bond can be availed at different terms. Most fixed-rate bonds make it mandatory for investors to deposit a minimum amount to initiate their accounts. A bond with comparatively longer-term attracts more returns and thus generates more earnings. Usually, the issuer of these bonds provides investors with the option to received interest either on a yearly or monthly basis. 

When compared to most savings and current accounts, this bond requires investors to deposit in a lump sum and generally at the time of initiating the account. At the time of maturity, investors can either withdraw the money or transfer it to another account. They can also reinvest the same into another account. This decision basically depends on the bond issuer or on the terms of the instrument. 

MERITS OF INVESTING IN A BOND

1. Stability and Security:

The predominant advantage of investing in bonds is stability and safety. The investors here are aware of the returns they will earn at the end of their tenure. In comparison to other fixed savings option, investing in fixed-rate bonds offer better returns. They serve as an investment avenue for parking funds as per the requirements of investors. 

2. Overcome the market volatility:

The bonds can overcome the volatility and adversity of markets, i.e. the recession period. They are less risky and helps investors to develop a better financial plan and align the same to the achievement of their financial goals.

3. Credit Worthiness:

Generally, the corporates and government issue bonds to raise funds. The credit rating agencies rate these bonds on the basis of their creditworthiness. Nevertheless, corporate bonds are riskier than government bonds.

IS IT WORTH INVESTING IN FIXED RATE BONDS

These bonds are considered a good instrument to include in the portfolio. It is ideal for investors who aim to generate a fixed and guaranteed return for a given tenure. On maturity, the investor will receive the principal amount along with the interest payment. Investors with a good understanding of risk and low-risk tolerance levels can opt for them to build a diversified portfolio. 

A long-term bond generates higher returns when compared to a short-term bond. Adding to it, the lock-in period ranged from 1 to 5 years. Generally, the fixed-rate bond issuers provide investors with an option to receive interest either annually, semi-annually or monthly. Most of the bonds issued by the government are fixed-rate bonds, to name a few, treasury bills, Certificate of Deposit among others. 

ADVERSE SIDE OF INVESTING IN BONDS

The major demerit of investing in fixed-rate bonds is market volatility and interest rate risk. Investors can lose out on opportunities of generating good and extraordinary returns when inflation rises. Bond prices are indirectly proportioned to returns which means bond prices rise when interest rates go down and bond prices fall when the interest goes up. Also, the price of the bond at maturity might be less than the price at the issue. In case investors are willing to do premature withdrawal they will need penalties for the same. 

Credit risk is also one of the factors to consider. Sometimes the issuer might default in the repayment obligation of interest and principal if they face cash flow problems. Therefore, the investor must check the credit rating of these bonds before investing in them. Moreover, long-term bonds are likely to associate with inflation risk as the rate keeps fluctuating frequently. 

CAN BONDS LOSE MONEY AND VALUE?

Generally, bonds are considered as a risk-free investment which is partially true. There is a guarantee of principal and interest payment on the maturity. But investors can lose money in case of selling the bond before maturity. The losses are subject to the selling price and penalty mentioned in the agreement. As we also discussed, investors can lose money due to credit risk, i.e. in case, the issuer defaults in repayment. Therefore, investors need to check the credit rating of the bonds before making an investment decision.