DEFINITION of Fixed Term
Fixed term describes an investment vehicle, usually some kind of debt instrument, that has a fixed time period of investment. With a fixed-term investment, the investor parts with his or her money for a specified period of time and is repaid his or her principal investment only at the end of the investment period. In some cases, even though a fixed term is stated on the investment, the investor or issuer may not have to commit to it.
BREAKING DOWN Fixed Term
A common example of a fixed-term investment is a term deposit in which the investor deposits his or her funds with a financial institution for a specified period of time and cannot withdraw the funds until the end of the time period, or at least not without facing an early withdrawal penalty. The investor, for the most part, is committed to the fixed term of this financial instrument. Once a term deposit reaches or approaches maturity, the investor must notify his or her financial institution to either re-invest the money into another fixed term investment or deposit the cash proceeds into his or her account. If the financial institution is not given any form of notification, proceeds from the mature term deposit automatically rolls itself over to another term deposit with the same fixed term as before. The interest rate can potentially be lower than the previous rate given that each new deposit is set at the current rate. A term deposit is the opposite of a demand deposit, in which the investor is free to withdraw his or her funds at any time.
As a price for the convenience of withdrawal at any time, demand deposits generally pay lower interest rates than term deposits.
Fixed terms also apply to debt instruments such as debentures and bonds. These securities are issued with a fixed term that may be short-, intermediate-, or long-term. The fixed term or time to maturity is stated in a bond indenture at the time of issuance. Unlike term deposits, bonds can be sold before they mature. In other words, investors are not committed to the fixed term of the security. For example, assume a bond is issued with 20 years to maturity. An investor can hold the bond for 20 years or can sell the bond before its term expires. The bond will continue to be traded in the secondary markets until it matures, at which point it will be retired.
Issuers can also retire a bond before it matures if the bond has an embedded call option. The trust indenture specifies the term a bond can be fixed for before an issuer redeems it from bondholders. For example, if a bond’s fixed term is 20 years, the call protection period may be seven years. In other words, the fixed term of the call protection is seven years and investors are guaranteed periodic interest payments on the bond for seven years. Once the call protection term elapses, the issuer can choose to buy back its bonds from the market regardless of the 20-year overall fixed term. Callable bond issuers are not committed to the fixed term of the bond.