Fixed Rate Bond

A fixed rate bond is a bond whose interest rate is set when it is issued and does not change until it is repaid. The issuer pays a constant coupon, expressed as a percentage of the face value, at regular intervals, and returns the face value to the holder on the maturity date. Because every cash flow is known in advance, it is the simplest and most common type of bond, used by governments, companies, banks and public agencies to borrow for periods from one year to several decades.

Fixed rate bonds are the basic form of bonds and are often called plain vanilla or straight bonds. They contrast with a floating rate note, whose coupon is reset periodically against a benchmark, and with a zero-coupon bond, which pays no interest and is sold at a discount. Most government bonds and the majority of investment-grade corporate issues carry fixed rates.

• Face value. The principal amount repaid at maturity, also called par value or nominal value.
• Coupon. The fixed annual coupon rate. A bond with a face value of 1,000 and a 4% coupon pays 40 a year, usually as two payments of 20 in the United States and United Kingdom and as one annual payment in much of continental Europe.
• Payment dates. Each coupon payment falls on a date set out in the coupon schedule.
• Maturity. In the standard form the whole principal is repaid on one date, making it a bullet bond. Variants repay in instalments or give the issuer a right to redeem early.
• Conventions. The terms specify the day count convention and the treatment of payment dates that fall on holidays.

Although the coupon is fixed, the market price of the bond is not. The price is the present value of the remaining coupons and the principal, discounted at the yield investors currently require:

Here $P$ is the price, $C$ the coupon per period, $F$ the face value, $y$ the yield per period written as a decimal, and $n$ the number of periods remaining.

Take a three-year bond with a face value of 100 and a 5% annual coupon when investors require 6%. Its price is $5 \div 1.06 + 5 \div 1.06^{2} + 105 \div 1.06^{3} \approx 4.72 + 4.45 + 88.16 = 97.33$. The bond trades below face value, at a discount, because its coupon is lower than the market rate. If the required yield were 4%, the price would be above 100, at a premium. The single discount rate that equates price and cash flows is the yield to maturity, and the mechanics are covered under bond pricing.

Quoted prices are normally clean prices, which exclude interest earned since the last coupon date. The buyer pays the seller that amount separately as bond accrued interest.

The fixed coupon gives certainty of income but exposes the holder to several risks.

• Interest rate risk. When market yields rise, the price of an existing fixed rate bond falls, and the longer its remaining life and the lower its coupon, the greater the fall. This sensitivity is measured by duration; see interest rate risk. A holder who keeps the bond to maturity still receives the promised cash flows.
• Inflation risk. Fixed payments lose purchasing power when inflation is higher than expected.
• Credit risk. The issuer may fail to pay. Investors demand a credit spread over government yields to compensate.
• Reinvestment risk. Coupons received may have to be reinvested at lower rates than the original yield.

For an issuer, a fixed rate locks in the cost of borrowing for the life of the bond, which helps budgeting and protects against rising rates, at the price of losing the benefit if rates fall. Issuers that prefer floating-rate funding can issue fixed and convert the payments with an interest rate swap. For investors, fixed rate bonds provide predictable income and are the main asset used by pension funds and insurers to match long-term liabilities. Their prices tend to rise when central banks cut rates and fall when they tighten, as the sharp losses on long-dated bonds in 2022 showed.

Operationally, a fixed rate bond is the easiest security to service. The coupon amount per unit of face value is the same on every regular date, so paying agents, depositories and custodians can calculate entitlements in advance from reference data. The main points of care are the first and last periods, which may be shorter or longer than standard, the record date for each payment, withholding tax, and any early or partial redemption. At maturity the final coupon and the principal are paid together and the bond is removed from holders' accounts.