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What is a Fixed Interest Security?

A fixed interest security is a fixed term obligation where the issuer (the borrower) undertakes to pay the holder of the security a fixed rate of interest (coupon) over the term of the investment plus repay the principal sum on maturity.

There are currently several types of fixed interest investments available in New Zealand. The more common ones can be broken into two categories; those that are tradeable such as government stock (also called government bonds, local authority stock (local government bonds) and corporate bonds; and others that are non-tradeable such as term deposits.
 
Tradeable fixed interest securities offer the holder a fixed level of income (interest) with the opportunity through the secondary securities market to on sell the fixed interest security prior to maturity to make a capital gain or to switch into a more attractive security.
 
In comparison, the same can apply to shares where income is paid by way of dividends and if the company is successful, the investment grows in capital terms, i.e. the share price rises. Likewise, losses can be made if values in share prices fall. Tradeable fixed interest securities rise and fall in value too. The credit spread (also called credit-margin) above the underlying market base interest rates (Government bond or bank swap) rises and falls depending on the financial performance, balance sheet strength and creditworthiness of the issuer. In this respect the pricing of the credit spread behaves in a similar fashion to a share price.
 
 
What affects the principal value of a tradeable fixed interest security?
 
Fixed interest coupon payments are normally paid over the life of the security until maturity. The coupon payment is fixed (cannot fluctuate) and is known at the time of investment. Generally these payments are made six-monthly.
After issue, the capital value of the security is market related and will fluctuate in value as market interest rates rise and fall. Interest rates and the period until maturity are the basis upon which tradeable fixed interest securities are valued in the open market. That is, if market interest rates drop below the interest rate being paid for the fixed interest security purchased, the value of the security is worth more and likewise, if interest rates rise, the value of the security is worth less.
 
When interest rates rise       =        Fixed interest values fall                                                            
                
           
When interest rates fall         =        Fixed interest values rise                                                         
                                             
 
Fixed interest coupon payments are normally paid over the life of the security until maturity. This coupon payment is fixed (cannot fluctuate) and is known at the time of investment. Generally these payments are made six-monthly.
After issue, the capital value of the security is market related and will fluctuate in value as market interest rates rise and fall. Interest rates and the period until maturity are the basis upon which tradeable fixed interest securities are valued in the open market. That is, if market interest rates drop below the interest rate being paid for the fixed interest security purchased, the value of the security is worth more and likewise, if interest rates rise, the value of the security is worth less.
 
Whilst the original face value is repayable on maturity, capital profits and losses arise in the secondary market because of changes in interest rates during the term of the investment. The premium or discount applicable at any time affects the net return achieved by the investor for the period the security has been owned.
When an individual investor purchases a bond and holds it to maturity, he or she will obviously not lose any capital value. If, however, during the term of the investment the bond is sold in the secondary securities market, a gain or loss may result against the original purchase price.