Invest in Fixed Interest Bonds

A fixed rate bond is a debt instrument that, as the name suggests, pays a fixed interest for its entire tenor. The rate that’s decided at issuance doesn’t change, no matter what happens to the rates outside of it.

Here’s how it works: Say you invest ?100,000 in a fixed rate bond with a 7% annual coupon and a 5-year term. Every year, you get ?7,000 in interest, and at maturity, you get your ?1 lakh back. That’s it. No recalculations, no resets, and almost zero dependency on external factors.

Bonds in India are issued by the government, PSUs, and private corporations, and the coupon, maturity date, and face value are all fixed and disclosed before the investment is made. 

How is the Return on a Fixed Rate Bond Calculated?

If you buy a bond at a face value of ?1,000 at a 9% coupon, your return is 9% per year. Simple.

Bonds are also traded on the secondary market and sometimes at different prices than face value. This is where Yield to Maturity comes to your aid. YTM is the total return that you receive when you hold the bond to maturity, including all the coupons and principal that is returned to you at the end of the bond's term. 

A quick extension of the example above helps explain it better: Suppose you buy the same bond at a discounted price of ?950. Your effective yield is now more than 9%, with the annual coupons plus the ?50 you earn when the issuer pays you back ?1,000 (the face value) at maturity.

Conversely, if you buy the same bond at a premium of ?1,050, your YTM is now lower than 8%. This is why two investors holding the same bond can have varying returns. It depends on the price at which they bought the bond.

Why Do Bond Prices Fall When Interest Rates Rise?

This is the part that throws many investors for a loop and the part that matters the most if you wish to liquidate before maturity.

The golden rule here is When interest rates rise, bond prices fall. When rates fall, bond prices go up. Here’s why this happens: Imagine you bought a bond at ?1,000 with a fixed coupon of 6%. RBI hikes rates, and new bonds offering 8% interest pop up in the market. And all of a sudden, your 6% bond looks less appealing. Since nobody will pay full price for a low-yielding instrument, the market price of your bond goes down to attract investors. The reverse stands true as well: if rates fall below 6%, your bond becomes highly attractive, and its price rises.

This only affects you if you decide to sell the bond before maturity. Held to maturity, a full face value repayment is cemented, making the price movements in the middle irrelevant.

Another concept that is helpful: duration. A gauge of bond sensitivity to interest rate changes. Long-term bonds are longer in duration and therefore will be more sensitive to rate changes. A 10 year bond is much more susceptible than a 2-year bond. 

Types of Fixed Rate Bonds Available in India

Yields are indicative and change with market conditions.

For retail investors, G-Secs via RBI Retail Direct and PSU bonds via platforms like GoldenPi are the most accessible entry points. Corporate bonds offer better yields but with a higher default risk attached.

When Should You Invest in Fixed Rate Bonds?

Timing plays more of a crucial role here than most investors realize. The ideal environment is when interest rates are up and likely to dip. Locking in at peak rates gives you an edge in two ways: a strong fixed income stream for the entire tenor and the potential for capital appreciation if rates fall and you choose to sell before maturity.

When rates are low and seeing an upward trend signals a bad time to enter. You’d be locking in a poor rate while the market rates surge, depreciating your bond’s value if you decide to sell before maturity.

This is also why fixed rate and floating rate bonds complement each other well. In a rising rate scenario, floating rate bonds offer better coupons, but once the trend shifts, fixed rate bonds take charge of driving better returns home. A well-thought-out debt portfolio often holds both.

What Are the Risks?

Fixed rate bonds are conservative instruments, but that doesn’t make them completely risk-free. Here’s what you should bear in mind:

• Interest rate risk—If rates rise, your bond’s price falls. Only relevant if you decide to exit early, but worth mentioning.
• Inflation risk—A fixed coupon in a high inflation environment is a bad bet.
• Credit risk- The issuer may default, becoming unable to pay you coupons or the principal. Here’s where credit ratings matter.
• Liquidity risk—Not all bonds are hot commodities on the secondary market. Some bonds can be hard to get off your portfolio quickly at a justified price.

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