Bonds are normally issued at face value, and can provide interest payments that are either fixed or variable in nature. After the issue date, but before the bonds mature, the level of interest rates in the economy may change. This has a different impact on the market value of fixed-rate and variable-rate bonds.
For a variable rate bond issued when rates are 6%, if interest rates fall to 5% or rise to 7% so will the periodic interest payments on the bond. If rates fall, the issuer benefits from a lower payment while the bondholder suffers. Conversely, the risk of rising rates is borne by the issuer for the benefit of the bondholder.
Fixed payment bonds reverse that risk profile, as the periodic interest payments will not change regardless of the market level of interest rates. A 6% bond will continue to make 6% interest payments whether market interest rates are 5%, 6% or 7%. When rates fall, the bondholder continues to receive the promised amount and earns an above-market interest rate. When rates rise, the bondholder receives an interest rate that is below market rates.
If the bondholder wants to cash out of the bond by selling it to another investor, that investor will want to pay an amount equal to the discounted value of future payments, based on the current market level of interest rates rather than the rate applied when the bond was issued. When market rates are lower than the bond’s stated rate, new buyers will be willing to pay an amount higher than the bond’s face value. When market rates are higher than the bond’s stated rate, new buyers will require a discount from the face value.For more information, see all articles on: Fixed income investments, Investing in bonds See also: