Floating-Rate Note (FRN)

Floating-Rate Note Debt Instruments Interest Rate Benchmark Rate LIBOR Investment Securities Bonds
A Floating-Rate Note (FRN) is a type of debt instrument with a variable interest rate that adjusts periodically based on a benchmark interest rate, such as the LIBOR or the federal funds rate.
On this page

Floating-Rate Note (FRN) Defined

A Floating-Rate Note (FRN) is a bond with an interest rate that fluctuates over time. Unlike fixed-rate bonds, which have a constant interest rate throughout their life, the interest rate on an FRN is periodically reset based on a reference rate or benchmark index. Common benchmarks include the London Interbank Offered Rate (LIBOR), the federal funds rate, or the prime rate. This adjustable rate mechanism helps the FRN maintain a value closer to its issuing price, reducing interest rate risk for investors.

Key Features

  • Interest Rate Adjustment: The interest rate on an FRN is typically adjusted every three to six months.
  • Reference Rate: Adjustments are based on a specific benchmark such as LIBOR, T-bill rate, or the federal funds rate.
  • Coupons: Interest payments (coupons) are made at each adjustment interval and reflect the new interest rate.
  • Lower Interest Rate Risk: FRNs are less susceptible to interest rate risk compared to fixed-rate bonds, as their rates are aligned with current market conditions.

Examples of Floating-Rate Notes

  1. U.S. Treasury Floating Rate Notes: These are FRNs issued by the U.S. Department of the Treasury. They adjust their interest rates based on the 13-week Treasury bill yield.
  2. Corporate Floating-Rate Bonds: Companies issue FRNs with rates tied to benchmarks like LIBOR or another index.
  3. Municipal Floating-Rate Bonds: Local governments and municipalities issue FRNs for funding projects, with rates often pegged to a specified reference rate.

Frequently Asked Questions (FAQs)

Q1: What is the advantage of investing in an FRN?

  • A: FRNs provide a hedge against rising interest rates as their yields adjust with market rates, offering more stable income compared to fixed-rate bonds.

Q2: How often do the interest rates of FRNs adjust?

  • A: The interest rates on FRNs generally adjust every three to six months, depending on the terms set at issuance.

Q3: Can the interest rate on an FRN ever be lower than its initial rate?

  • A: Yes, if the benchmark rate decreases, the interest rate on the FRN will also decrease.

Q4: Are floating-rate notes risk-free?

  • A: No. While they reduce interest rate risk, they still carry default risk, credit risk, and market risk.

Q5: Are FRNs suitable for all investors?

  • A: Generally, FRNs may be more suitable for conservative investors seeking income that adjusts with market conditions, though they might not be appropriate for those needing fixed and predictable income streams.
  • Interest Rate Risk: The risk that changes in interest rates will negatively affect the value of financial instruments.
  • Benchmark Rate: A standard interest rate or index that serves as a basis for setting the interest rate on a floating-rate financial product.
  • LIBOR (London Interbank Offered Rate): A widely-used benchmark interest rate at which banks lend to one another.
  • Coupon: The interest payment made to the bondholder on a set periodic schedule.

Online References

  1. Investopedia - Floating-Rate Note (FRN)
  2. U.S. Treasury – Floating Rate Notes
  3. Federal Reserve - FRNs

Suggested Books for Further Studies

  1. “Fixed Income Securities: Tools for Today’s Markets” by Bruce Tuckman and Angel Serrat
  2. “The Handbook of Fixed Income Securities” by Frank J. Fabozzi
  3. “Bond Markets, Analysis, and Strategies” by Frank J. Fabozzi

Accounting Basics: Floating-Rate Note (FRN) Fundamentals Quiz

### What is a floating-rate note (FRN)? - [ ] A bond that is issued with a fixed interest rate. - [x] A debt instrument with an interest rate that changes over time. - [ ] A preferred stock with a variable dividend rate. - [ ] An equity security that guarantees variable dividends. > **Explanation:** A floating-rate note (FRN) is a debt instrument with a variable interest rate that resets periodically, reflecting changes in a benchmark rate. ### How often do floating-rate notes usually reset their interest rates? - [ ] Monthly - [x] Every three to six months - [ ] Once a year - [ ] Semi-annually only > **Explanation:** The interest rates on floating-rate notes are generally reset every three to six months based on an agreed benchmark rate. ### What is a common benchmark used to adjust the interest rate on an FRN? - [ ] Dow Jones Industrial Average - [ ] Consumer Price Index - [x] LIBOR - [ ] Unemployment Rate > **Explanation:** A common benchmark used to adjust the interest rate on an FRN is the London Interbank Offered Rate (LIBOR). ### Which of the following is true about floating-rate notes (FRNs) compared to fixed-rate bonds? - [ ] They carry higher interest rate risk. - [ ] They are immune to changes in interest rates. - [ ] Their payouts remain constant over time. - [x] They have a variable interest rate that adjusts periodically. > **Explanation:** Floating-rate notes (FRNs) have a variable interest rate that adjusts periodically, which means they have lower interest rate risk compared to fixed-rate bonds. ### What happens to the interest rate of an FRN if the benchmark rate decreases? - [ ] The interest rate remains unchanged. - [ ] The principle of the FRN changes. - [ ] The interest rate increases. - [x] The interest rate decreases. > **Explanation:** If the benchmark rate decreases, the interest rate of the FRN will also decrease accordingly. ### Why are FRNs considered to have lower interest rate risk? - [ ] They have a fixed interest rate. - [x] Their interest rate adjusts with changes in market interest rates. - [ ] They are short-term instruments. - [ ] They are always backed by government guarantees. > **Explanation:** FRNs are considered to have lower interest rate risk because their interest rates adjust with changes in market interest rates, protecting the investor from rate volatility. ### Which type of investor might prefer FRNs over fixed-rate bonds? - [ ] Investors seeking stable and predictable income. - [x] Investors concerned about rising interest rates. - [ ] Investors looking for high-risk, high-reward opportunities. - [ ] Investors uninterested in market conditions. > **Explanation:** Investors who are concerned about rising interest rates might prefer FRNs because the adjustable interest rate on FRNs can help mitigate the effects of rate increases. ### Which risk remains for investors despite the floating rate adjustment of an FRN? - [ ] Interest rate risk - [x] Credit default risk - [ ] Inflation risk - [ ] No risk at all > **Explanation:** Despite the floating rate adjustment, investors in FRNs still face credit default risk, which is the risk that the issuer may not be able to make interest or principal payments. ### Can the interest rate of an FRN be higher than its initial rate? - [x] Yes, if the benchmark rate increases. - [ ] No, it remains at the initial rate. - [ ] No, it will only decrease. - [ ] Yes, but only during the first adjustment period. > **Explanation:** Yes, if the benchmark rate increases, the interest rate on an FRN can also increase above its initial rate. ### What aspect of a floating-rate note protects its value better compared to a fixed-rate bond in rising interest rate environments? - [ ] Principal repayment flexibility - [ ] Issuer backing - [x] Periodic interest rate adjustments - [ ] Long duration > **Explanation:** The periodic interest rate adjustments protect the value of a floating-rate note better compared to a fixed-rate bond in rising interest rate environments.

Thank you for exploring the detailed world of Floating-Rate Notes and taking on the challenge of our informative quiz. Continually enhancing your financial knowledge will fortify your expertise in accounting and investments!

Tuesday, August 6, 2024
Flood Insurance
Floating-Rate Note (FRN)
Below Par January 1, 1
Exchange-Traded Notes (ETNs) January 1, 1
Face Value January 1, 1
Fungible Issue January 1, 1
Going Long January 1, 1
New Money January 1, 1
Par Value January 1, 1
Redeemable Bond January 1, 1
Serial Bonds January 1, 1
Series Bonds January 1, 1

Accounting Terms Lexicon

Discover comprehensive accounting definitions and practical insights. Empowering students and professionals with clear and concise explanations for a better understanding of financial terms.