Unlock Capital II: Fixed-rate and Floating-rate Bonds

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Bonds are a staple of the global investment landscape, offering investors a variety of options to suit their financial goals. Among the most prominent types of bonds are fixed-rate and floating-rate bonds, each with distinct structural features and advantages.

Issuers

Both fixed-rate and floating-rate bonds can be issued by a variety of entities, including:

  • Governments: National and regional governments issue both types of bonds, which are typically viewed as low-risk investments. Examples include U.S. Treasury bonds, UK Gilts, and German Bunds.
  • Corporations: Large corporations issue bonds to raise capital for various business activities, often offering higher yields compared to government bonds to compensate for increased risk.
  • Financial Institutions: Banks and financial institutions issue bonds to meet funding needs and manage capital requirements, often using floating-rate bonds to hedge interest rate risk.

Coupon Rate

One of the primary differences between fixed-rate and floating-rate bonds is the coupon rate:

  • Fixed-Rate Bonds: These bonds have a fixed interest rate throughout their life. For example, a bond with a 3% annual coupon rate pays a consistent amount of interest regardless of changes in market interest rates.
  • Floating-Rate Bonds: The interest rate on these bonds is variable, tied to a reference rate such as the London Interbank Offered Rate (LIBOR) or the Secured Overnight Financing Rate (SOFR). The coupon rate is typically expressed as a spread over the reference rate (e.g., “LIBOR + 1%”), and adjusts periodically, usually every 3 or 6 months.

Maturity Date

Both fixed-rate and floating-rate bonds can have various maturities:

  • Fixed-Rate Bonds: These can range from short-term (less than 3 years) to long-term (over 10 years), with government bonds often having longer maturities to align with public infrastructure projects.
  • Floating-Rate Bonds: These bonds are often issued with shorter maturities (1 to 5 years), especially by corporations and financial institutions to match specific funding needs or hedge against rising interest rates.

Face Value

The face value is the nominal amount the issuer agrees to repay at maturity. Both fixed-rate and floating-rate bonds typically have face values ranging from local currency equivalents of US$1,000 to US$1,000,000.

  • Retail Bonds: These are targeted at individual investors and tend to have lower face values.
  • Institutional Bonds: These are aimed at institutional investors such as pension funds and often have higher face values.

Interest Payment Structure

  • Fixed-Rate Bonds: Interest payments are predictable and usually made semi-annually or annually. For example, a bond with a 4% coupon rate would pay 2% every six months.
  • Floating-Rate Bonds: Interest payments are made at regular intervals, often every 3 or 6 months, with the coupon rate adjusting based on the reference rate at the time of the reset.

Advantages and Risks

Fixed-Rate Bonds:

Advantages:

  • Predictable, stable income.
  • Easier to understand, especially for new investors.

Risks:

  • Interest Rate Risk: If market interest rates rise, the bond’s price may decline.
  • Inflation Risk: Fixed payments may lose purchasing power if inflation rises.

Floating-Rate Bonds:

Advantages:

  • Protection against rising interest rates, as coupon payments adjust upward.
  • Lower price volatility compared to fixed-rate bonds in a rising interest rate environment.

Risks:

  • Income Variability: If interest rates fall, coupon payments will decrease.
  • Credit Risk: Floating-rate bonds, like any bond, carry the risk of issuer default.

Update:

  • As of 30 September 2024, the remaining synthetic LIBOR settings (which emerged as a transition measure since LIBOR’s official end in June 2023) have been published for the last time. All LIBOR settings have now permanently ceased.
Contact us to explore how our team can support your bond issuance strategy and capitalize on Hong Kong’s dynamic financial opportunities.
 

Dominic Sze YTL LLP

Dominic Sze, Senior Of Counsel 

(E: dominicsze@hkytl.com T: +852 3468 7200)

This article is introductory in nature. Its content is current at the date of publication.  It does not constitute legal advice and should not be relied upon as such. You should always obtain legal advice based on your specific circumstances before taking any action relating to matters covered by this article. Some information may have been obtained from external sources, and we cannot guarantee the accuracy or currency of any such information.