Definition of Variable-Rate Note
A Variable-Rate Note (VRN) is a bond with a fixed maturity date but with an interest coupon rate that adjusts at regular intervals to reflect the ongoing market rates. The adjustment is typically based on a margin over the London Interbank Offered Rate (LIBOR). Unlike a floating-rate note (FRN), the margin on a VRN is not fixed and may be adjusted at each coupon setting date to account for present market conditions.
Examples
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Example 1: Suppose a company issues a VRN with an initial interest rate of LIBOR + 2%. During the first coupon-setting period, if the LIBOR is 3%, the coupon rate is 5%. If, at the next setting, the market conditions change and LIBOR increases to 4%, and the margin adjustment mechanism results in a reduction of the spread to 1.5%, the new coupon rate becomes 5.5% (4% LIBOR + 1.5% margin).
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Example 2: An investment firm purchases a VRN tied to LIBOR, with quarterly rate adjustments. During one quarter, if the LIBOR is at 2% and the margin agreed upon is 0.5%, the interest received for that period will be 2.5%. In the next quarter, assuming market conditions change leading to an adjustment of the margin to 0.6% and LIBOR to 3%, the new interest payment will be 3.6%.
Frequently Asked Questions (FAQs)
What is the main difference between a VRN and an FRN?
The main difference is that in a VRN, the margin over the base rate (such as LIBOR) is adjustable and can change at each interest-reset period, based on market conditions. In contrast, an FRN has a fixed margin that remains the same throughout the life of the note.
How often are the interest rates adjusted in a VRN?
The interest rates on a VRN are typically adjusted at regular intervals, such as monthly, quarterly, or semi-annually, depending on the terms specified at issuance.
What mechanism determines the adjusted margin on a VRN?
The adjusted margin on a VRN may be determined by market conditions, pre-defined negotiation clauses, or performance benchmarks set in the bond’s covenants.
Are VRNs considered riskier than fixed-rate notes?
VRNs can be riskier in terms of interest payments due to fluctuation with market rates; however, they can also offer better yield opportunities in rising interest rate environments. They can mitigate risk if rates fall since payments adjust.
What are the typical underlying indices for VRNs?
Typical underlying indices for VRNs include the London Interbank Offered Rate (LIBOR), the Federal Funds Rate, or other short-term benchmark rates.
Related Terms with Definitions
- Bond: A fixed income instrument that represents a loan made by an investor to a borrower.
- Floating-Rate Note (FRN): A bond with a variable interest rate that adjusts periodically, typically with a fixed margin over a reference rate like LIBOR.
- LIBOR (London Interbank Offered Rate): A benchmark interest rate at which major global banks lend to one another.
- Coupon Rate: The yield that the bondholder earns annually based on the bond’s face value.
- Interest-Rate Risk: The risk that an investment’s value will change due to a change in the absolute level of interest rates.
Online References
- Investopedia - Variable-Rate Note
- Federal Reserve Bank - Floating and Variable Rate Notes
- Morningstar - Bond Basics
Suggested Books for Further Studies
- “Fixed Income Analysis” by Barbara S. Petitt and Jerald E. Pinto: This book provides an in-depth understanding of bonds and fixed income instruments including VRNs and FRNs.
- “Bond Markets, Analysis, and Strategies” by Frank J. Fabozzi: An advanced guide covering bond instruments, market behavior, and detailed analysis.
- “The Handbook of Fixed Income Securities” by Frank J. Fabozzi: A comprehensive resource covering various fixed income instruments, their mechanisms, and investment strategies.
Accounting Basics: “Variable-Rate Note” Fundamentals Quiz
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