Floating-Rate Note
IntermediateA floating-rate note (FRN) is a bond whose interest rate is not fixed but resets periodically, usually every three or six months, based on a benchmark interest rate plus a fixed margin.
The coupon on a floating-rate note moves with market interest rates. For example, an FRN might pay SOFR plus 0.75%. If SOFR is 4%, the coupon is 4.75%; if SOFR falls to 3%, the coupon falls to 3.75%.
Because the coupon adjusts, the price of an FRN stays close to its face value, so it carries much less interest rate risk than a fixed-rate bond. Its price changes mainly if the issuer’s credit quality changes.
FRNs are issued by banks, companies and governments. They appeal to investors who expect interest rates to rise or who want to limit interest rate risk, such as money market funds and banks matching floating-rate liabilities.
The trade-off is that income falls when interest rates fall. FRNs still carry the issuer’s credit risk. Since the end of LIBOR, most new floating-rate notes reference overnight benchmark rates, such as SOFR in the United States and SONIA in the United Kingdom, usually compounded over each interest period.
For worked examples and full lessons, visit notesbysara.org.