Governments borrow money from investors through issuing debt securities called bonds. When a government issues bonds, it agrees to pay interest on the money that is owed to the person holding the bond. Usually, payments are semiannual; but, for purposes of this discussion, payments are assumed to be annual (and the government is assumed to be the US government). The annual interest rate is called the coupon rate. Generally, this coupon rate can be structured in two ways: fixed or floating.
As the name suggests, when a government bond carries a fixed interest rate, the government has agreed to pay a set annual interest rate for the life of the bond. Therefore, if the interest rate is fixed at 7%, then the government will semiannually pay the bond holder 7% of the remaining debt in addition to the principal payment, which is equal to the original borrowed amount divided by the number of periods.
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There are advantages and disadvantages associated with both types of interest rate...