Definition / Meaning
Floating rate bonds, also known as floating-rate notes, are a type of bond characterized by a floating rate of interest. A floating rate of interest means a rate of interest derived using a benchmark or reference rate, which could be any external interest rate like U.S. Treasury Bill Rates, LIBOR, EURIBOR, Federal Funds Rate, etc. Normally, a margin or spread is added to the reference rate, and the coupon rate is denoted as ‘LIBOR + 1%’, ‘EURIBOR + 1%’, or ‘Federal Funds Rate + 1%’.
Since these bonds have a semi-variable interest rate, they are also called floaters. They are the complete opposite to fixed-rate bonds. These types of bonds are normally issued by government organizations, institutional investors, mutual funds, etc., for tenure between 2 to 5 years.
Impact of Interest Rate Fluctuations
When the interest rate rises, fixed-rate bonds lose value. In contrast, these floaters are not impacted because the interest receivable to the investor also rises with the rise in the market interest rate. On the other side, when the market interest rates fall, fixed-rate bonds gain value, but there is no beneficial impact because the interest receivable on floaters is also reduced.
The value of these bonds is not affected much when the interest rate market fluctuates. In other words, they are free from interest rate risk as far as the investors are concerned.
Floating Rate Bond Funds and ETF
There are funds that are only investing in debt instruments having a floating rate of interest. And these funds are called floating-rate bond funds or floating rate funds. To add to the concept, when these funds are traded in the open market, they are called Floating Rate Bond ETF, where ETF stands for exchange traded funds. Some of the examples of top funds of the US in this category are as follows:
- iShares Floating Rate Bond ETF (FLOT)
- SPDR Barclays Capital Investment Grade Floating Rate ETF (FLRN)
- VanEck Vectors Investment Grade Floating Rate ETF (FLTR)
- AdvisorShares Pacific Asset Floating Rate ETF (FLRT)
Floating Rate Bond Duration
It should be noted that the duration is not the same as the maturity of a bond. Maturity is simply that time remaining before receiving the final payment. On the other hand duration of a bond is arrived at based on a complicated formula. The essence of calculating duration is to gauge the bond’s sensitivity with respect to the changes in the interest rate market. Both duration and maturity are denoted in years. In the case of zero-coupon bonds, the maturity and duration are both the same.