Also known as Floating Rate Notes, FRN, Floaters.
These make floating rate interest payments that are linked to an index.
The coupons are reset periodically in line with a pre-determined benchmark such as an interest rate index.
Floating rate bonds have an interest rate that is adjusted over time (usually semi annually) and is linked to the rate of some benchmark bond (for example a government bond)
Also not all bonds have a fixed par value.
Inflation-protected bonds (such as Treasury Inflation Protected Securities or TIPS) for example have a principal that is adjusted peridocially (usually semi annually) by inflation.
This implies that although the interest rate of these bonds is fixed, their interest payments are not because the principal on which they are calculated changes over time.
coupon = floating rate interest rate The price of a floating rate bond is always equal to its face value (show the proof) Two relationships between spot and forward rates You can use the short selling technique as a way of pricing a forward
Floating Rate Note - Reverse/Inverse
As the interest rate goes up the interest on the FRN goes down and vica versa
The coupon rate could be variable in cases where the rate of interest is changed periodically in line with maket rates.
As the word "Bond" implies a fixed rate of interest, bonds where the coupon rate varies are referred to as "floating rate notes"
If issued in London, the coupon may be defined as LIBOR + or - 45 basis points, reviewed every 6 months.
These protect against a rise in interest rates
Common Indices include: money market indices, such as LIBOR or Euribor, or CPI (the Consumer Price Index).
Coupon examples: three month USD LIBOR + 0.20%, or twelve month CPI + 1.50%.
FRN coupons reset periodically, typically every one or three months. In theory, any Index could be used as the basis for the coupon of an FRN, so long as the issuer and the buyer can agree to terms.
The obviously carry a lower yield than fixed rates of the same maturity
The interest rate adjustment is usually made every 6 months and are tied to a certain money-market index.
Bonds with coupon rates that are reset periodically based on a margin or spread over a reference rate
Popular rates are 3/6 month libor/euribor
The margin or spread is expressed in basis points or as a function of a percentage (eg libor + 0.0625%)
Many FRN issues specify a minimum rate (floor) and/or a maximum rate (cap or ceiling) that the coupon rate on the bond cannot breach.
Index linked gilts pay a rate of interest and a redemption value based on the change in the Retail Price Index in the same period.
Caps and Floors
Some floating rate securities have restrictions placed on how high or how low the coupon can be.
This is a restriction on the maximum coupon rate that will be paid at a reset date
Spread on a Floating Rate Note
Things are simplified with FRNs where margin above a floating rate index is reset periodically.
Initially it would be expected that the margin would equate to the credit spread as the bond would usually have a price of par.
However as credit conditions change the bond will naturally trade at a premium or discount.
The overall return (the discount margin) is the sum of the initial stated coupon plus/minus the value of the premium or discount spread "spread out" over the life of the note.
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