Introduction Bonds bring income and diversification to a portfolio, while typically carrying less risk than stocks. With the right approach, you can get steady returns and stability from bonds. However, not all bonds are created equal. In this article, we will delve into the differences between floating-rate bonds and fixed-rate coupon bonds, focusing on the reduced risk associated with floating-rate bonds.
Understanding Floating-Rate Bonds and Fixed-Rate Coupon Bonds A bond is a fixed-income investment that represents a loan made by an investor to a borrower, usually corporate or governmental. Fixed-rate coupon bonds have a predetermined interest rate that remains fixed throughout the bond's tenure. On the other hand, floating-rate bonds have variable interest rates that adjust periodically, typically based on a benchmark such as LIBOR.
Interest Rate risk One of the key risk that investors face when investing in bonds is interest rate risk. Long-term bonds are most sensitive to interest rate changes due to their fixed-income nature. When interest rates rise, the value of fixed-rate coupon bonds decreases, as their fixed interest payments become less attractive compared to new bonds with higher interest rates. Floating-rate bonds, on the other hand, have interest rates that adjust to market conditions, reducing the impact of interest rate fluctuations.