Definition / Meaning
Floating rate bonds, also known as floating rate notes, are a type of bond characterized by floating rate of interest. Floating rate of interest means a rate of interest that is derived using a benchmark or reference rate which could be any external rate of interest like U.S. Treasury Bill Rates, LIBOR, EURIBOR, Federal Funds Rate etc. Normally, there is a margin or spread added to the reference rate and the coupon rate is denoted like ‘LIBOR + 1%’, ‘EURIBOR + 1%’, or ‘Federal Funds Rate + 1%’.
Since, these bonds are having semi variable rate of interest, they are also called floaters. They are 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 interest rate rise, fixed rate bonds lose value whereas these floaters are not impacted because the interest receivable to the investor also rise with rise in market interest rate. On the other side, when the market interest rates fall, fixed rate bonds gains value but there is no beneficial impact because the interest receivable on floaters also reduces.
The value of these bonds are not affected much when the interest rate market fluctuate. 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 fund which are only investing debt instruments having 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 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 same as 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 based on complicated formula. The essence of calculating duration is to gauge the sensitivity of a bond with respect to the changes in interest rate market. Both duration and maturity are denoted in years. In case of zero coupon bonds, the maturity and duration are both same.