Fixed, floating or inflation linked?

Fixed, floating or inflation linked?


A fixed-rate bond, pays a fixed return for
the life of the bond and is set at the time of the issue. Hence, the rate of coupon is locked in, and will not change over the term of the loan. They are similar to term deposits. The interest you receive is set. There is one key difference though, bonds are trade-able securities. Because of this, fixed-rate bonds have an inverse
relationship to interest rates. If interest rates rise, the the price of the bond falls. Alternatively, if interest rates fall, then the price of the bond rises. This is because the only way that bonds
can reflect changes in the market’s expectations of interest rates is through price movement. Important to know, when you buy a bond, the value of that fund may fluctuate however this does not affect the coupon rate. Let me give you a simple example, if you held a fixed-rate bond and it paid a coupon of 6%, and current interest rates were 4% than the market would value that bond more because it is paying 2% above that current interest rate of 4%. Alternatively, if interest rates begin to rise and they rise above the coupon rate of 6% then that fixed-rate bond would
decrease in value. Nevertheless, if you hold the bond to maturity you will receive your hundred dollar face value. Floating-rate notes, pay a coupon that’s linked to a variable benchmark. the benchmark is the 90 day bank-bill swap rate. BBSW for short and it’s just simply the bond market’s
cash rate. The margin over the benchmark is fixed, and it said at the time of issue this is also known as a coupon. The coupon rises and falls over time, this is because the bank-bill swap rate changes daily. it is the market’s view on interest
rates let me give you an example if the market believes that interest rates will
increase in the near future then the bank-bill swap rate will also increase. if the market believed in the future, that interest rates were
going to fall then the bank bill swap rate will also begin to fall. the key difference here is that floating-rate notes have much less interest-rate risk and this is because their coupon rates increase and decrease with the market’s
expectations of interest rates. inflation-linked bonds are securities that
are linked to the consumer price index or inflation. the most common type is the capital index bond the capital index bond has a fixed
coupon and it’s usually quite low usually between two and three percent however the principal is linked to inflation each quarter the principal component
increases with headline inflation the coupon is then multiplied by the
increased principal component let me give you an example if you bought a capital index bond for a
hundred dollars and the coupon was 5% and inflation for that year was ten
percent, than the value of over that year will be
increased to one hundred and ten dollars you would then multiply the 5%
coupons increased principal component of a
hundred and ten dollars which would then give you a rate of $5.50 hence not only is your principal
increasing with inflation year-on-year but so is your income. So in summary, we have fixed-rate bonds that pay a fixed rate over the life of the bond and price is mainly affected by interest rate movements. We have floating-rate notes which move in line with the bond
market’s cash rate, and finally, we have inflation-linked bonds, where your principal and income, keep pace with inflation.

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