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Fixed rate bonds and floating rate bonds are both categories of debt instruments, but they differ significantly in how their returns respond to market conditions. The key difference between them lies in their interest rates: while fixed-rate bonds offer a fixed interest or coupon rate throughout their maturity period, floating-rate bonds adjust their coupon rate periodically based on their linked benchmark rates, protecting against inflation and interest rate risk. Investors should invest in bond based on their investment horizon, risk tolerance and financial goals.
What are Fixed Rate Bonds
Fixed rate bonds are debt instruments wherein the coupon payments remain fixed or unchanged till the maturity date. Most government bonds are issued as fixed-rate bonds. For instance, Sovereign Gold Bonds (SGBs) are fixed-rate bonds. They provide a fixed coupon rate of 2.50% p.a. on the initial investment amount and interest payments are made at semi-annual intervals.
Features
- The interest rate of fixed rate bonds is determined as a percentage of the face value of the bond.
- The coupon interest payments can be made semi-annually, annually, or at maturity.
- These bonds may have a puttable or callable bond option depending on the terms and conditions of the bond.
- These bonds are ideal for conservative investors seeking predictable income and capital protection.
What are Floating Rate Bonds
Floating rate bonds are debt instruments whose coupon rates are revised at periodic intervals. The coupon rates are linked to pre-set benchmark rates like MCLR (Marginal Cost of Funds Based Lending Rate), NSC (National Savings Certificate) rates, repo rate, T-Bill yields, etc. Therefore, the interest payments on these bonds may increase or decrease as per the movements in their linked benchmark rates. Also known as floaters or variable rate bonds, these bonds are issued by both government and companies.
Features
- The interest rates of floating rate bonds can be reset at monthly, quarterly, half yearly, annually or other pre-specified intervals.
- The base rate of the bond is linked to the benchmark rate, whereas the spread is fixed at the time of bond issuance or decided through an auction process at the time of bond issuance.
- Investors seeking market-aligned interest income and/or lower volatility in bond prices can consider floating rate bonds.
Fixed Rate Bond vs. Floating Rate Bond: How to Choose?
Choosing between fixed and floating rate bonds depends on the investor’s interest rate outlook, financial goals, risk tolerance, and investment horizon.
| Particulars | Fixed Rate Bonds | Floating Rate Bonds |
| Coupon structure | Fixed throughout the maturity period | Benchmark (e.g., repo rate or Treasury bill rate) + Spread |
| When to Invest | During a stable or falling interest rate regime, as high locked-in interest rate becomes valuable | During a rising interest rate regime as coupon interest rate rises when the interest rate rises |
| Who Should Invest | Conservative investors seeking higher income stability or a higher scope of capital appreciation | Return-oriented investors seeking market-aligned interest income or lower volatility in bond prices |
| Investment Horizon | Longer durations as it provides certainty over the long haul. This ensures predictable future cash flows | Short durations, as these bonds are less sensitive to market interest rate fluctuations |