Agency Bond RatesBond Instruments
Agency bond rates are typically fixed, paying a set interest rate per year. Most agency bonds follow a fixed straight debenture format, paying a specific amount of interest and then returning the principal to the investor at maturity. Other fixed interest agency bonds are zero-coupon bonds. They sell initially at a discount and pay both principal and interest at maturity. Most of the agency bonds which are zero-coupon bonds are short term holdings.
There are a few variable rate bonds, which change based on the issue. A Floating Rate bond is attached to a central bank, such as the London Inter-Bank Offered Rate, or the government bond’s rates. These bonds pay monthly interest according the changing rates of the standard. If the benchmark rises, your payment will rise, if it falls your payment rate will also fall.
A Mortgage Based security is used to acquire capital which fuels mortgage loans. The interest is paid based on the rate the mortgage borrowers repay their debts. If they pay quickly, you receive payments rapidly and can reinvest earnings quickly. If they pay slowly, you receive interest and principal slowly and will reinvest income at that rate. It’s important to note that you receive both interest and principal at their repayment rate. Your principal may not be returned to you at maturity. If it was returned over the course of the bond’s payments, your payments will simply end before then. The important note is that these investments are based on the actions of a collective group of people.
A step bond has a coupon rate which changes on a specific date. Each time the date changes, the rate rises slightly above what it was before. The rates and dates of change will be written into the bond contract. These aren’t truly variable rate bonds, since they can only rise in rating and the changes the bond will encounter are scheduled in advance. The biggest problem is the call feature usually attached to these bonds, which is more likely to be used when the bond has stepped up to higher rates.
It should be noted that any bond which is callable could be revoked at any time whether fixed or variable. In this case you will receive the par value but no longer receive any interest. You should always investigate if the agency bond you are purchasing is callable and ensure that you are willing to accept the return earned if the bond is called.
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