What is a Floating‑Rate Note (FRN)?
A floating‑rate note (FRN), often called a “floater,” is a fixed‑maturity debt security whose coupon (interest) rate varies over time. Instead of paying a fixed rate for the life of the bond, an FRN’s coupon resets periodically and is tied to a published benchmark (for example, a short‑term Treasury rate, the federal funds rate, LIBOR historically, or a prime rate). Because the coupon moves with market rates, FRNs give investors partial protection from rising interest rates and typically exhibit lower price volatility than comparable fixed‑rate bonds.
Key takeaways
– FRNs have variable coupons that reset at pre‑specified intervals based on a benchmark.
– They are issued by governments, banks, and corporations, commonly in maturities of a few years.
– FRNs tend to pay lower initial yields than fixed‑rate bonds but adjust upward if benchmark rates rise.
– They reduce, but do not eliminate, interest‑rate risk and still carry issuer credit/default risk.
– Some FRNs include caps, floors, or callable features that affect returns and risk.
How FRNs work
– Benchmark and spread: An FRN coupon is typically expressed as “benchmark + spread.” Example: 3‑month LIBOR + 0.50%. The benchmark provides the floating component; the spread reflects credit compensation above the benchmark.
– Reset frequency: The prospectus specifies how often the coupon resets (daily, weekly, monthly, quarterly, etc.). The investor receives whatever coupon results during each period.
– Coupon payments: Payments may be monthly, quarterly, semiannual, or annual depending on the security.
– Pricing and market value: Because coupons adjust, FRN prices are less sensitive to rate changes than fixed‑rate bonds. However, changes in credit spreads, liquidity, or benchmark behavior can still move prices.
– Caps and floors: Some FRNs have maximum (cap) and/or minimum (floor) coupon limits, which limit upside or downside on income.
Types of FRNs
– By issuer: Government/Treasury FRNs, bank/financial‑institution FRNs, corporate FRNs, supranational issues.
– By feature: Callable FRNs (issuer may redeem early) vs. non‑callable FRNs. Callable floaters typically pay higher spreads to compensate investors for early‑call risk.
– By benchmark: Treasury bill‑linked FRNs, LIBOR/SOFR‑linked FRNs, prime‑linked, etc. (Note: many markets migrated from LIBOR to alternative benchmarks such as SOFR.)
Advantages
– Interest‑rate sensitivity: Less price volatility when interest rates rise because coupons increase.
– Income that adjusts with market rates: Potentially better purchasing power in rising‑rate environments.
– Flexibility: Useful for investors seeking short‑to‑medium duration exposure with protection against rising short‑term rates.
Risks and limitations
– Benchmark mismatch / underperformance risk: The FRN’s benchmark may not rise as quickly as broader market rates, so income can lag.
– Credit/default risk: If the issuer defaults, investors may lose principal or future coupons.
– Coupon unpredictability: Variable payments complicate cash‑flow planning.
– Caps/floors and callable features: These can limit the benefit of rising rates or lead to early redemption.
– Liquidity risk: Secondary‑market liquidity varies—some FRNs trade thinly.
– Market/price risk remains: FRNs can lose value if credit spreads widen or if market conditions change.
U.S. Treasury FRNs (brief)
The U.S. Treasury began issuing FRNs in 2014. Treasury FRNs are marketable government securities with characteristics intended to provide investors floating exposure to short‑term Treasury rates. Typical features include:
– Short maturity (two years for the Treasury FRN series introduced in 2014).
– Coupon that resets at a regular interval and is linked to a short‑term Treasury bill rate (the most recent 13‑week Treasury bill auction rate is used for the Treasury floaters).
– Regular interest payments (quarterly for Treasury FRNs).
– Marketable and noncallable; can be bought at auction, on the secondary market, or directly through Treasury channels (e.g., TreasuryDirect).
(For full official details on Treasury FRN terms and auctions, consult Treasury materials and the note’s prospectus.)
Example (illustrative)
Issuer offers FRN: benchmark (3‑month rate) + 0.50%, resets quarterly.
– Quarter 1: benchmark = 0.75% → coupon = 1.25%
– Quarter 5: benchmark has risen to 2.75% → coupon = 3.25%
An investor’s coupon payments rise or fall each reset period according to the benchmark level plus the fixed spread.
Practical steps for investors considering FRNs
1. Define your objective
– Are you seeking protection against rising short‑term rates, short‑duration income, or a lower‑volatility alternative to fixed‑rate bonds? Your objective will guide whether FRNs fit your portfolio.
2. Check the benchmark and transition risk
– Identify the benchmark (e.g., 3‑month Treasury, SOFR, previously LIBOR). If the market is transitioning benchmarks (e.g., LIBOR → SOFR), understand how the contract establishes the alternate reference.
3. Confirm reset frequency and payment schedule
– More frequent resets (daily/weekly/monthly) track rate moves faster; quarterly resets are common. Check when coupons are paid (monthly/quarterly/etc.) for cash‑flow planning.
4. Examine spread, caps/floors, and call features
– The quoted spread is your compensation above the benchmark. Caps limit upside; floors limit downside. Callable FRNs give the issuer the right to redeem early—assess how that affects expected returns.
5. Evaluate issuer credit and liquidity
– Assess credit quality (ratings, balance sheet) and secondary‑market liquidity. Corporate FRNs carry credit risk; government FRNs (e.g., Treasury) have essentially sovereign credit backing.
6. Compare alternatives
– Compare an FRN’s expected income and risk to short‑term bonds, money‑market funds, floating‑rate bond funds/ETFs, and bank products. Consider total return, not just coupon.
7. Consider tax and account implications
– Understand tax treatment of interest and whether the security fits in taxable vs. tax‑advantaged accounts.
8. Decide how to buy
– Primary issuance: Buy at auction (TreasuryDirect for Treasury FRNs or dealer auctions for corporates).
– Secondary market: Use a broker to buy existing FRNs (price depends on time to next reset, accrued interest).
– Funds/ETFs: If diversification or easier liquidity is desired, consider floating‑rate mutual funds or ETFs that hold many FRNs.
9. Monitor benchmark behavior and issuer fundamentals
– Stay alert to benchmark movements, central‑bank policy, and issuer credit changes that might influence income and market value.
10. Use portfolio tactics
– Ladder FRNs (stagger maturities) for smoother cash flow.
– Pair FRNs with fixed income to diversify duration exposure.
– Consider FRNs as part of a defensive allocation when you expect rising short‑term rates.
When FRNs make sense
– You expect short‑term rates to rise, and you want coupons that adjust upward.
– You prefer lower price volatility versus fixed‑rate bonds of similar maturity.
– You want government‑backed floating exposure (e.g., Treasury FRNs) to minimize credit risk.
When FRNs may not be ideal
– You need predictable fixed income for budgeting (FRN coupons vary).
– You expect long‑term rates to fall substantially and want to lock in current higher yields.
– You require highly liquid secondary trading in a niche corporate FRN market that may be thin.
Further reading and source
This article is based on industry summaries of floating‑rate notes and details compiled by Investopedia. For the Investopedia primer on FRNs, see: https://www.investopedia.com/terms/f/frn.asp
For exact terms, auction details, and legal prospectus information on any specific FRN (especially Treasury FRNs), consult the issuer’s prospectus and the U.S. Treasury’s official resources before investing.