Fairway Bond - Explained
What is a Fairway Bond?
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Table of ContentsWhat is a Fairway Bond?Characteristics of a Fairway BondFloating Interest Rate vs Interest Rate OptionAcademic Research on a Fairway Bond
What is a Fairway Bond?
A fairway bond is a type of bond that pays interest only when the underlying interest rate or interest index is within a specific range, once the interest index is outside the range, the bond makes no interest payment. When the underlying interest rate of the bond maintains a specific range, the bond is termed a fairway bond. Hence, people that invest in fairway bonds benefit from it when there is no significant upward or downward movement of interest rate in the market. Once the bond maintains the specified range, profit is ensured. A fairway bond is also called an index floater, a corridor bond or a range accrual note.
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Characteristics of a Fairway Bond
A typical fairway bond has a floating rate, investors who seek to maximize profit for a period of time for which a bond is held purchase fairway bonds. Fairway bonds are often the preferred choice of traditional investors, they invest in it hoping that there would be no significant upward and downward patterns in the market. When the underlying interest rate index in the market goes beyond the specific interest rate of fairway bonds, no interest is paid. Investors of fairway bonds have nothing to worry about even when the interest rates become higher because they will still get the bond's principal at redemption or maturity time.
Floating Interest Rate vs Interest Rate Option
One of the major attributes of fairway bonds is that they have floating interest rate which is often short-termed. However, in the case of a normal floating interest rate, a bond of this nature follows market trends, its interest is affected by up and down movements in the market. However, because fairway bonds have short-term floating interest rates, they are regarded as index floaters. Fairway bonds use short-term interest rates such as LIBOR. Interest rate options, on the other hand, enable a bondholder to benefit from changes in interest rates, a bondholder can use the call or put options depending on how favorable the interest rates are.