Overview
A Floating-Rate Note (FRN) is a financial instrument with a variable interest rate that is typically linked to a benchmark rate, such as the London Interbank Offered Rate (LIBOR). This dynamic rate allows the interest payments of the FRN to adjust periodically, reflecting current market conditions, which can benefit investors in fluctuating interest rate environments. FRNs are often issued as negotiable bearer bonds, which means they are not registered and ownership is determined by possession.
Key Characteristics
- Adjustable Rate: The interest rate on an FRN resets regularly, usually every three to six months.
- Benchmark Rates: FRNs commonly use LIBOR as the benchmark rate, with an additional spread to determine total interest payout.
- Bearer Bonds: Often issued as bearer bonds, meaning they are transferable by physical delivery.
- Variance in Types: Includes perpetual FRNs (without a redemption date) and capped FRNs (with a maximum interest rate limit).
Examples
- Eurobond with LIBOR: A multinational corporation issues an FRN tied to the 6-month LIBOR rate plus a 1.5% spread. If the 6-month LIBOR rate is 2%, the FRN will pay 3.5% interest for that period.
- Corporate Perpetual FRN: A bank issues a perpetual FRN without a redemption date, paying variable interest throughout its indefinite term.
- Capped FRN: A company floats an FRN with its interest rate tied to the LIBOR plus a spread, but the interest rate is capped at 5% regardless of how high the LIBOR rate goes.
Frequently Asked Questions
Q1: What is the main advantage of investing in a Floating-Rate Note? A1: The main advantage is the protection against rising interest rates. Since the interest rate adjusts periodically, FRNs can offer higher returns in an increasing rate environment compared to fixed-rate bonds.
Q2: How often do interest rates on FRNs typically reset? A2: Interest rates on FRNs usually reset every three to six months, depending on the terms specified in the bond agreement.
Q3: Are Floating-Rate Notes considered safe investments? A3: FRNs can be considered relatively safe investments, especially when issued by reputable institutions. Their variable interest rate mitigates some of the interest rate risk associated with fixed-rate bonds.
Q4: What is a perpetual FRN? A4: A perpetual FRN is a type of floating-rate note that has no redemption date, meaning it continues to pay interest indefinitely.
Q5: What does ‘capped FRN’ mean? A5: A capped FRN has an upper limit on the interest rate it can pay, protecting the issuer from paying excessively high interest during extreme rate increases.
Related Terms
- Eurobond: An international bond issued in a currency not native to the country where it is issued.
- London Interbank Offered Rate (LIBOR): A benchmark rate that some of the world’s leading banks charge each other for short-term loans.
- Bearer Bond: A bond that is not registered in the name of any owner, hence the physical holder of the bond is presumed to be the owner.
- Variable-Rate Note: Similar to a floating-rate note but differs in the specifics of how the variable rate is determined.
Online References
- Investopedia – Floating Rate Notes
- MarketWatch – Floating Rate Notes
- The Balance – Floating Rate Bonds
Suggested Books for Further Studies
- Fixed Income Securities: Tools for Today’s Markets by Bruce Tuckman and Angel Serrat.
- Bond Markets, Analysis, and Strategies by Frank J. Fabozzi.
- The Handbook of Fixed Income Securities edited by Frank J. Fabozzi.
Accounting Basics: “Floating-Rate Note” Fundamentals Quiz
Thank you for exploring the intricacies of Floating-Rate Notes and testing your understanding with our quiz. Best of luck in your financial studies!
