Floating Debt is a term used to describe a company’s or government’s short-term obligations that are frequently refinanced, typically through various financial instruments. Businesses often use floating debt by taking out short-term loans or issuing commercial papers due within a year. Governments issue Treasury bills and short-term Treasury notes which fall under the category of floating debt. Unlike long-term debt, such as Treasury bonds considered as funded debt, floating debt remains in flux and is continually rolled over by issuing new short-term debt as the old ones mature.
Examples
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Business Scenario:
- Commercial Paper: A corporation may issue commercial paper to meet its short-term funding needs. For instance, a company needs funds to manage its working capital and does so by issuing commercial paper for six months.
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Government Scenario:
- Treasury Bills: The U.S. government issues Treasury bills that mature in one year or less. These are continuously refinanced by issuing new bills as the old bills mature to manage short-term borrowing needs.
Frequently Asked Questions (FAQs)
What is floating debt?
Floating debt is the short-term financial obligations of a business or government that are frequently refinanced rather than repaid outright.
How does floating debt differ from funded debt?
Floating debt consists of short-term obligations that are continually rolled over, such as commercial papers and Treasury bills. Funded debt refers to long-term obligations, such as Treasury bonds, with fixed repayment schedules.
Why do companies use floating debt?
Companies use floating debt for managing short-term liquidity needs, operational costs, and other immediate financial requirements without committing to long-term debt.
What are the risks associated with floating debt?
The principal risk associated with floating debt is the potential increase in interest rates, which can make the cost of refinancing more expensive over time. Additionally, an inability to refinance could lead to liquidity issues.
How does a government manage its floating debt?
Governments manage floating debt by issuing short-term securities like Treasury bills and short-term notes and rolling over these instruments as they mature.
Related Terms with Definitions
- Commercial Paper: An unsecured, short-term debt instrument issued by corporations to meet immediate financing needs.
- Treasury Bill: Short-term government securities with maturities ranging from a few days to one year.
- Funded Debt: Long-term debt instruments with maturities typically over one year, such as bonds.
Online References
- Investopedia: Floating Debt
- Corporate Finance Institute: Floating Debt
- U.S. Treasury Department: Treasury Bills
Suggested Books for Further Studies
- “Financial Management: Theory & Practice” by Eugene F. Brigham and Michael C. Ehrhardt - A comprehensive guide on the principles of financial management, including short-term and long-term financing.
- “Corporate Finance” by Jonathan Berk and Peter DeMarzo - Offers detailed insights into various financial strategies, including the use of short-term and long-term debt instruments.
Fundamentals of Floating Debt: Finance Basics Quiz
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