What Are the Functions of Fixed-Rate Bonds?

Fixed-rate bonds are the most common form of long-term debt financing. Fixed-rate bonds offer benefits to both investors and issuers because the uncertainty of variable-rate financing is eliminated. Fixed-rate bonds give a known stream of income to investors, while stabilizing costs for the issuer. Fixed-rate financing is usually reserved for long-term financing and not for short-term debt issues. Fixed-rate financing consists of semi-annual principal and interest payments, or just interest and a single 'balloon' debt repayment.

Fixed-Rate Financing Controls Costs

• Variable-rate financing is not reasonable for long-term financing. Interest rates directly affect the feasibility of many long-term projects. The use of variable-rate financing makes it impossible to know how to charge for rent, or to price in the cost of factory or manufacturing space, because interest rates are a major component of an institution's cost structure. Bond financing are debt instruments with maturities between 10 and 30 or more years.

Fixed-Rate Bonds Allow for the Refunding of Debt

• Fixed-rate bonds allow owners to refinance existing structures that are in full use when interest rates are low, providing additional savings. A building or business started during a period of high interest rates can permanently reduce and control costs through fixed-rate financing. Should rates fall further, management can reduce costs by refinancing the project with lower cost bonds.

Fixed Interest Rates Provide Stability to Investors

• Investors prefer fixed-rate bonds because they want to lock in a competitive yield for a predetermined number of years. Investors prefer to make long-term commitments at fixed rates so they will have steady cash flow. Variable-rate financing means that the rate of interest could be higher or lower at the next reset date, and thus cannot be used for maintaining a stable dividend to investors.

Fixed-Rate Bonds Allow Better Debt Management

• If a company has fixed-rate bonds to pay debt and the company wishes to expand, it can do so by raising more debt financing. This is called junior financing and is payable only after previous fixed-rate debt is serviced. Companies also have the opportunity, if the credit is sound, to swap their debt into other currencies where they may be able to reduce interest expense further. Adding or swapping debt is very difficult if the existing debt is variable and short term in nature.

Fixed-Rate Bonds Attract More Institutional Funding

• Fixed-rate bonds are the preferred choice of investment for large institutions. Pension funds, mutual funds, both life and casualty insurance companies prefer the known cash flow of fixed-rate bonds. With the need to invest billions of dollars every day to offset long-term claims and dividend policies these companies actively seek to invest at a fixed rate they can lock in for years. Variable-rate maturities are used for short-term bills and notes that provide liquidity rather than income to investors.