Definition of Floating-Rate Note

Financial Terms Beginning with F

What is a Floating-Rate Note (FRN)

A floating-rate note (FRN) is a financial instrument with a variable interest rate that adjusts periodically based on a benchmark interest rate or reference rate, such as the London Interbank Offered Rate (LIBOR) or the Prime Rate. These notes are also commonly known as "floaters" or "variable rate notes." Floating-rate notes are a significant component of the fixed income market and are used by governments, corporations, and financial institutions to raise capital and manage interest rate risk.

The primary characteristic of a floating-rate note is its interest rate, which is not fixed like traditional fixed-rate bonds. Instead, the interest rate on an FRN "floats" or changes over time, typically in sync with changes in the chosen reference rate. This rate adjustment occurs at predetermined intervals, such as monthly, quarterly, or annually, and is usually expressed as a spread or margin over the reference rate. The spread represents the additional interest that investors receive above the reference rate to compensate for the associated credit risk.

Benefits of Floating-Rate Notes

Floaters offer several advantages to both issuers and investors. For issuers, these securities provide a way to access the bond market without locking in a fixed interest rate, which can be beneficial in a volatile interest rate environment. They can also attract a broader range of investors, as floaters are less susceptible to interest rate fluctuations.

Investors, on the other hand, are drawn to floating-rate notes because they provide a degree of protection against rising interest rates. When market interest rates increase, the coupon payments on floaters rise as well, preserving the note's relative value. This feature makes floating-rate notes attractive during periods of expected or actual interest rate hikes, as they can provide a hedge against interest rate risk.

Types of Floating-Rate Notes

Floating-rate notes are typically issued with maturities ranging from one to ten years, but longer maturities are also available. Investors often buy floaters for portfolio diversification and income stability, especially in times of economic uncertainty when interest rates are expected to fluctuate. A point of interest, the term floating-rate bond is a close synonym and is a commonly used phrase to describe the same financial instrument.

Final Thoughts on Floating-Rate Notes

In summary, a floating-rate note, or floater, is a financial instrument with a variable interest rate that adjusts periodically based on a reference rate. These notes are important in the fixed income market, offering issuers flexibility and investors protection against interest rate fluctuations. Understanding the mechanics of floating-rate notes is crucial for both issuers and investors looking to manage their interest rate exposure effectively.

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