This website uses cookies to ensure you have the best experience. Learn more

Floating Vs. Fixed Interest Rates Essay

705 words - 3 pages

Governments borrow money from investors through issuing debt securities called bonds. When a government issues bonds, it agrees to pay interest on the money that is owed to the person holding the bond. Usually, payments are semiannual; but, for purposes of this discussion, payments are assumed to be annual (and the government is assumed to be the US government). The annual interest rate is called the coupon rate. Generally, this coupon rate can be structured in two ways: fixed or floating. As the name suggests, when a government bond carries a fixed interest rate, the government has agreed to pay a set annual interest rate for the life of the bond. Therefore, if the interest rate is fixed at 7%, then the government will semiannually pay the bond holder 7% of the remaining debt in addition to the principal payment, which is equal to the original borrowed amount divided by the number of periods. When the government issues bonds with floating interest ...view middle of the document...

There are advantages and disadvantages associated with both types of interest rate structures. We will look at it from an investor's perspective. The fixed rate structure offers two major advantages to investors. The fixed rate bondholder will have a consistent and predictable series of payments. Also, a fixed rate bondholder will benefit when inflation is lower than projected. Using the previous example, the holder would be receiving 7% interest. If the CPI was expected to be 4%, then the investor would be expecting to receive a real interest rate of 3%. If inflation turns out to be 3%, then the investor would receive a real interest rate of 4%, a 1% increase in the real value of that interest payment. The fixed rate structure also has disadvantages. If inflation is higher than expected, then the effects of the previous example would be reversed; and, the investor would receive a lower interest payment in real terms. Therefore, the fixed rate bond investor is not protected from inflation risks like the floating rate bondholder would be. The major advantage to holding floating rate bonds is their protection against inflation. The floating rate bondholder is paid a specific rate in addition to inflation; so, no matter what happens to inflation, the bondholder will receive interest payments of the same value in real terms. For this decrease in risk, the floating rates are usually a little lower than fixed rates. In exchange for no inflation risk, the investor gives up two advantages to having fixed rates. The payment stream is not predictable. Also, there is no potential for the interest payments to increase in real value when inflation is lower than expected. The different characteristics of floating and fixed interest rate structures offer different levels of opportunity and risk to potential investors. These two rate structures offer a choice for investors: 1.) inflation risk with opportunity for increased value in real terms, and 2.) no inflation risk with a concrete, unchanging value in real terms. The two rate structures provide important options for both the government and investor. They act as important tools for governments and investors to achieve their goals.

Other Essays On Floating Vs. Fixed Interest Rates

Financial Liberalization Essay

8415 words - 34 pages attempts to liberalize their financial sectors by deregulating interest rates, eliminating or reducing credit controls, allowing free entry into the banking sector, giving autonomy to commercial banks, permitting private ownership of banks and liberalizing international capital flows.A number of empirical studies have been conducted on the link between interest rate liberalization and economic growth in many developing countries. In particular, the

Has The Federal Reserve Outlived Its Purpose?

1900 words - 8 pages Gregory 1Keera GregoryDennis DunkinEng 1227 May 2014Has the Federal Reserve Outlived Its Purpose?With the everyday fluctuation of interest rates and the continuous downward spiral of the value of the United States dollar, it's not uncommon to wonder what elements contribute to these constant changes. When the government is in debt and they want to send millions of dollars to Syria, does a guard just open up a vault and deliver the money? Who

Dunham Cosmetics - Financial Evaluation

1397 words - 6 pages may be inconvenient, constraining the firm's future actions. Short-term credit agreements are generally less restricted.By the time the funds are obtained, interest costs will be lower if the firm borrows on a short-term rather than a long-term basis. Even though short-term rates are often lower than long-term rates, short-term credit is riskier for two reasons:1.f a firm borrows on a long-term basis, its interest costs will be relatively stable

The Scope Of Observation Research In The Collection Of Qualitative Data

781 words - 4 pages observed.Structures Vs. Unstructured StructuredThe approach to be followed is specified in detail including what behaviours are to be observed. The study is pre-determined. UnstructuredThe approach is not specified and the behaviour to be observed is not precisely defined. Observers record all aspects of behaviour.DirectVs.Indirect DirectBehaviour is observed as it occurs. IndirectRecord of past behaviourHumanVs. Mechanical HumanHuman observers are

Labour Economics

1516 words - 7 pages on changes to the job market. ' Women as a group of labour participants have risen from 38 percent in 1965 to 54 percent in 2002'.(ACTU) The female participation rate in the job market started to increase significantly during the early 1980's as high interest rates and low real wages took their toll on household incomes. Women constantly try to balance economic needs with family needs and self-development leading to shifts in participation rates

Marketing Differences B2B & B2C

1283 words - 6 pages B2B's website to learn more about the product's features, benefits and the B2B's services that can be provided. (B2b Vs B2c Email, 2008).B2C Marketing PlanThe marketing plan for a B2C will focus on turning a shopper into a buyer. The B2C marketing plan tends to be aggressive and consistent in order to always covey the same message to the consumer. The marketing tools used consist of coupons, offers and web displays in order to sway the consumer into

A Mass Spectrometer Inlet System For Sampling Gases Dissolved In Liquid Phases

4128 words - 17 pages Kammermeyer (1). The dif- ferences in permeation rates of the films to the gases suggest a useful property, the possibility of "tailoring" an inlet system to pass the gas of interest and retain another gas. For instance, polyethylene admits COZ faster than Hz, but the reverse is true for trithene. This property effects a "concentra- tion" of a gas perhaps present in low con- centration, resulting in an increase in sen- sitivity over a

Amcor - Case Study

4689 words - 19 pages such as interest rate and currency swaps to hedge underlying financial or commercial transactions.(Amcor, n.d.)4.2 Interest Rate RiskAmcor has various debts that are exposed to fluctuation in interest rates. So it manages its interest rate risk by monitoring global interest rates and evaluating appropriate hedging interest rate exposures. When global interest rates decreased marginally, Amcor's ratio of fixed-rate debt to total debt increased

New EU States And The Adoption Of The Euro

3551 words - 15 pages of plus or minus 15% has been put in place as acceptable for all accession states. * (4) Long-term interest rate: fulfilled by eight of the ten new member states (the Czech Republic, Cyprus, Latvia, Lithuania, Malta, Slovenia, Slovakia and Estonia). The long term interest rates cannot be more than 2% higher than the average of the three countries with the best inflation performance. Fig. 2: displays how all of the accession countries are

The Inflation Of Macau

1285 words - 6 pages 1996 to 31/2 percent in 1997 and further to about 1/4 percent in 1998. In the statistical record of Macau SAR, its first price deflationary year was 1998 and this also marked the beginning of a series of annual deflation. This, together with sharp increases in nominal interest rates in the last two years, led to increases in real interest rates, which in turn contributed to sluggish economic activity. The unemployment rate increased over the

Brandinf

6830 words - 28 pages production costs and transportation costs, both are major fixed costs. Furthermore, as mentioned before, growing health concerns are going to somewhat force companies in this industry to start offering healthier and smarter choices for their everyday soft drink needs.2.1 Key Success FactorsThere are also numerous key success factors that every major competitor must have in order to survive. To endure the crucial competitiveness within this industry

Similar Papers

Role Of Reserve Bank Of Australia And Interest Rates

2010 words - 9 pages Definition of Interest RateAn interest rate is the percentage yield on a financial security or asset such as a loan, bond or savings deposit. A variety of interest rates exist in the economy because of differences in the risk, liquidity and maturity of various financial instruments or assets.Different Types Interest Rates (% per annum)Bank Current Deposit (at call) - 0.00%, June 2005Cash Rate Target - 5.50% (+0.25%), 2nd March 2005Banks Fixed

Computer Benchmarking Essay

720 words - 3 pages processors configured with identical peripherals and software. MIPS can be the execution speed of a computer. For instance, 5 MIPS is 5,000,000 instructions per second. Modern personal computers often perform at 100 MIPS. MIPS rates are not uniform. Some are averages while some are peak performances. In addition, it takes more instructions on some machines to perform the same function (RISC vs. CISC, mainframe vs. micro). Because of this, MIPS are

Should The Uk Join The Euro Or Remain Master Of Its Own Fiscal Destiny. What Are The Arguments For And Against?

3005 words - 13 pages , raising interest rates to deflate the economy or devaluing thecurrency to stimulate inward investment and export growth. The ECB acting in theinterest of the currency rather than individual member states could itself have adestabilising effect on some members. Unlike continental Europe, Britain haspredominantly variable rate mortgages, making it more susceptible than fixed rate mainland Europe to changing interest rates. Indeed lower ECB

Macroeconomic Review Of Japan

9970 words - 40 pages during the Great commodities depression of 1982-1998.Deflation in JapanDeflation started in the early 1990s. The Bank of Japan and the government have tried to eliminate it by reducing interest rates, but despite having them near zero for a long period of time, they have not succeeded.Systemic reasons for deflation in Japan can be said to include:Fallen asset prices. There was a rather large price bubble in both equities and real estate in Japan