Lesson 8 of 12
The floating rate notes (FRNs) are bonds that offer a variable rate of interest to the investors.
The floating rate is determined based on a reference rate, such as LIBOR, or any other reference rate. The floating rate on the notes will be specified as the reference rate (LIBOR) plus the spread.
There are primarily two types of floating-rate notes:
Floating rate bonds: These are floating rate securities that reference a short-term reference rate (less than one year). An example reference rate is LIBOR. For such securities, the reference rate is reset frequently, generally quarterly.
Adjustable-rate bonds: These are floating rate securities that reference a long-term reference rate (more than one year). An example is a 10-year Constant Maturity Treasury (CMT) bond yield. For such securities, the reference rate is not required to be set frequently.
The advantage of floating rate notes is that they are immune from interest rate risk, and also have a duration close to zero. As the market rates increase or decrease, so do the coupons on the FRNs; this way their price remains constant.
FRNs usually do better than the fixed-rate bonds when interest rates increase and vice-verse.