INTRODUCTION
Topic ----- Fixed Interest Coursework
Brief Description On—
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Introduction to Fixed Interest
Simple Interest
Compound Interest
Fixed-Interest Security
Interest Coverage Ratio
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A fixed-rate mortgage FRM
How it works/Example
Why it Matters
Fixed interest credit cards
Benefits of investing in fixed interest
Risks of investing in fixed interest
Risks of investing in fixed interest
Examples of fixed interest investments
 Benefits of FD
 Taxability
FIXED INTEREST
Types of interest rates
 Variable rate
 Fixed rate
 Partially-fixed rate
 Introductory rate
As the name suggests, fixed means that cannot be changed later, where the
interest doesn’t fluctuate during the fixed rate period of the loan. A fixed interest
rate is based on the lender's assumptions about the average discount rate over
the fixed rate period. A fixed rate allows you to lock in an interest rate on y loan,
typically for 1 to 5 years. This safeguards you against future interest rate rises. It
also helps you plan your finances because you know exactly how much you will be
repaying.
Earlier fixed interest was meant only for financial investors to when their appetite
for risk dwindled and their need for regular income grew. But , as on now “fixed
interest” is like a blanket term that is used to describe a suite of complex and
often bewildering securities- products that can suspend distributions at will and
even become equities if the right triggers are pulled, but which are still marketed
under the auspices of safety.
Moreover, a fixed interest rate is based on the lender’s assumptions about the
average discount rate depending upon the fixed rate period. The capital value of a
fixed rate loan is generally determined as a function of future interest rates at the
time of calculation. i.e., they contain a capital risk, in that if interest rates fall, the
capital value of the loan rises, and vice versa. This differs from a variable rate
loan, where the capital value is always the original loan less any capital
repayments.
If you need the current account credit over a longer period of time, this can be
utilized wholly or partially in the form of a fixed advancement. You then benefit
from a fixed interest rate over the agreed term.
Interest is a fee or compensation paid by the borrower to the lender. By way of
accumulation, the interest rate can be categorized into simple interest and
compound interest.
Compound Interest means that you earn "interest on your interest", while Simple
Interest means that you don't - your interest payments stay constant, at a fixed
percentage of the original principal.
Simple Interest and Compound Interest
Compound Interest means that you earn “interest on your interest”,
while Simple interest means that you don’t—your interest payments stay
constant, at a fixed percentage of the original principal.
Simple Interest Formula
Let’s say that P is your starting principal, r is the interest rate (expressed
as a decimal), and Y is the number of years you invest. Then your future
value will be:
P (1 + rY)
(Simple Interest)
P (1 + r)Y
(Annually Compounded Interest)
The two formulas give the same answer for one year. After that,
compound interest takes off.
So it is obvious that compound interest is a better investment, which seems both
obvious and moot - after all, bank accounts always pay compound interest
anyway. Even a bond investment is really compound interest if you think about it:
you get fixed coupons (that's simple interest) but you can invest them to get
interest on them (compound interest).
The situation where simple interest occurs naturally is when the principal doesn't
change over time. This is true with an interest-only mortgage, for example, where
your monthly payments only pay the interest on your loan, but don't pay down
the loan itself.
'Fixed-Interest Security'
A fixed-interest security pays a specified rate of interest that does not change
over the life of the instrument. The face value is returned when the security
matures. Fixed-interest securities are less risky than equities, since in the event
that a company is liquidated, bondholders are repaid before shareholders.
However, bondholders are considered unsecured creditors and may not get any
or all of their principal back.
Fixed-interest securities are also subject to interest-rate risk. Since their interest
rate is fixed, these securities will become less valuable as rates go up in a risinginterest-rate environment. If interest rates fall, however, the fixed-interest
security becomes more valuable.
'Interest Coverage Ratio'
A ratio used to determine how easily a company can pay interest on outstanding
debt. The fixed charge coverage ratio is a financial ratio that measures a firm's
ability to pay all of its fixed charges or expenses with its income before interest
and income taxes. The fixed charge coverage ratio is basically an expanded
version of the times interest earned ratio or the times interest coverage ratio.
The fixed charge coverage ratio is very adaptable for use with almost any fixed
cost since fixed costs like lease payments, insurance payments, and preferred
dividend payments can be built into the calculation.
The interest coverage ratio is calculated by dividing a company's earnings before
interest and taxes (EBIT) of one period by the company's interest expenses of the
same period:
The lower the ratio, the more the company is burdened by debt expense. When a
company's interest coverage ratio is 1.5 or lower, its ability to meet interest
expenses may be questionable. An interest coverage ratio below 1 indicates the
company is not generating sufficient revenues to satisfy interest expenses.
‘Fixed Deposits’
Fixed deposits are a high-interest -yielding Term deposit offered by banks in India.
The most popular form of Term deposits are Fixed Deposits, while other forms of
term Deposits are Recurring Deposit and Flexi Fixed Deposits (the latter is actually
a combination of Demand deposit and Fixed deposit).Generally, the longer the
term of deposit, higher is the rate of interest but a bank may offer lower rate of
interest for a longer period if it expects interest rates, at which the Central Bank
of a nation lends to banks will dip in the future.
Benefits of FD
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Customers can avail loans against FDs up to 80 to 90 per cent of the value
of deposits. The rate of interest on the loan could be 1 to 2 per cent over
the rate offered on the deposit and.
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Resident of India can open these accounts for a minimum 3 months.
Taxability
Tax is deducted by the banks on FDs if interest paid to a customer at any bank
exceeds Rs. 10,000 in a financial year. This is applicable to both interests payable
or reinvested per customer. This is called Tax deducted at source and is presently
fixed at 10% of the interest. However, tax on interest from fixed deposits is not
10%; it is applicable at the rate of tax slab of the deposit holder. If any tax on
Fixed Deposit interest is due after TDS, the holder is expected to declare it in
Income Tax returns and pay it by himself. If total income for a year does not fall
within the overall taxable limits, customers can submit a Form 15 G (below 60
years of age) or Form 15 H (above 60 years of age) to the bank when starting the
FD and at the start of every financial year to avoid TDS.
‘Fixed-rate mortgage (FRM)’
A fixed-rate mortgage (FRM), often referred to as a "vanilla wafer" mortgage
loan, is a fully amortizing mortgage loan where the interest rate on the note
remains the same through the term of the loan, as opposed to loans where the
interest rate may adjust or "float". As a result, payment amounts and the duration
of the loan are fixed and the person who is responsible for paying back the loan
benefits from a consistent, single payment and the ability to plan a budget based
on this fixed cost.
Other forms of mortgage loans include interest only mortgage, graduated
payment mortgage, variable rate mortgage (including adjustable-rate mortgages
and tracker mortgages), negative amortization mortgage, and balloon payment
mortgage. Unlike many other loan types, FRM interest payments and loan
duration is fixed from beginning to end.
Fixed-rate mortgages are characterized by amount of loan, interest rate,
compounding frequency, and duration. With these values, the monthly
repayments can be calculated.
How it works/Example:
The most common types of mortgages carry either a fixed or variable interest
rate. While the variable rate can change over time, the fixed rate is set usually as
a given amount above the 30 year Treasury bond rate at the time of setting.
The benefit of a fixed interest rate loan or mortgage is the stability of the
payment over a period of time. In the case of home mortgages, this is usually a
30-year period. In this scenario, the borrower can budget his payments without
worrying what the future interest rate market will be. Most of the initial
payments go toward interest on the loan and only a small portion reduces the
principal of the loan. As the principal is reduced the corresponding interest charge
is reduced, thus enabling more of the payment to reduce the principal. This
process takes place for 30 years until the last payment consists entirely of
principal and no interest
A disadvantage is that fixed rate interest is usually higher than the variable rate.
Why it Matters:
The choice between fixed and variable rates depends on both personal factors
such as the borrower's family and employment status, and market factors such as
the interest rate climate.
A borrower may opt for a fixed interest rate if he is concerned that rates will be
going up and he is a more risk-averse investor.
Fixed Interest Credit Cards
Credit Card Company may not always have your best interests in mind when
signing up for one of their cards. These are the ways that can help for
unnecessary penalties and also lesson your interest payments. Some fixed
interest loans - particularly mortgages intended for people with previous adverse
credit - have an 'extended overhang'
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Fixed Interest Rate Cards Can Be Increased
Two Possible Penalties on a Single Late Payment
Penalty Rates Can Extend to All of Your Credit Cards
Balance Transfer Checks Can Cost You More
Benefits of investing in fixed interest
Fixed interest investments should form part of a diversified investment portfolio
and can offer the following benefits:
1) Regular income returns at a set interest rate, which can be fixed for a specified
term, providing greater certainty than shareholder dividends
2) Repayment of initial investment on maturity
3) If interest rates fall, you generally continue earning the higher initial rate of
interest until maturity.
Risks of investing in fixed interest
No doubt other fixed interest investments are generally secure, investments, but
there are risks also. For example, like shares, fixed interest investments are not
guaranteed. If the issuing company fails, investors may lose all or part of their
initial investment. It’s important to remember however that some fixed interest
investments, such as corporate bonds, generally rate higher than shares in the
issuing company’s credit structure and therefore where an issuing company is
wound up, have priority in any return of capital to investors.
Fixed interest investments offer investors a regular income for a specified term
with the expectation that the principal will be repaid at the end of the term
(maturity date).
Fixed interest investments usually issued by corporations, government and semigovernment bodies and financial institutions such as banks to raise funds.
Examples of fixed interest investments include:
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Corporate bonds
Government and semi-government bonds
Capital notes
Debentures and
Income securities