What is a Floating Rate Bond?

A floating rate bond is known as a variable rate bond. These bonds are referred to as a type of debt instrument where the interest rate is not fixed, but it changes periodically based on the benchmark, like the repo rate or treasury bill rate. These bonds aim to protect investors against interest rate risk by adjusting the interest payouts based on the current market price. The floating rate bonds provide flexibility and adaptability to investors in changing market conditions. This article explains what is a floating rate bond, how they work, their advantages, disadvantages, and more.  

How Floating Rate Bonds Work?  

The following key points explain how floating rate bonds work in the Indian market: 

• Like the standard bonds, the floating rate bonds pay periodic interest and return the principal at maturity.  
• The interest rate is different because it is linked to a benchmark that moves up or down with the market conditions. 
• When the benchmark changes, the revised rate is applied to the bond on scheduled reset dates. 
• These resets ensure the coupon remains close to prevailing market rates rather than staying fixed. 
• As a result, investors usually face lower interest rate risk, particularly when overall interest rates are rising. 

Example of Floating Rate Bond  

For a better understanding of what is a floating rate bond, here is an example: 

• Let’s say a corporate bond issued by the Rajkot (Gujarat) Solar Energy Pvt. Ltd. in January 2017 was structured as a floating rate instrument. 
• The bond’s interest rate was linked to the Marginal Cost of Funds Based Lending Rate (MCLR), meaning the lending rate used by banks served as its reference point. 
• So, whenever the MCLR moved, the bond’s coupon was revised to reflect the new rate. 
• As a result, the interest paid to investors will not remain constant but will change depending upon every update in the benchmark. 

Now that the floating rate meaning is explained along with the example, the next step is to understand the different classifications of a floating rate bond. 

Different Classifications of a Floating Rate Bond 

The following are the different classifications of a floating rate bond. 

1. Government-issued FRNs: 
   These floating-rate bonds are issued by the government of India. These bonds are generally viewed as low-risk as they are backed by sovereign credit. 
2. Corporate-issued FRNs: 
   Corporate-issued FRNs are issued by private or public companies. They generally offer higher interest potential as compared to government FRNs but they come with additional credit risk. 
3. Benchmark-based FRNs: 
   The coupon rate on these bonds is directly linked to market benchmarks such as the Reserve Bank of India (RBI) repo rate, or other widely used reference rates. 
4. Fixed-margin FRNs: 
   The fixed margin FRNs are paid at a variable rate that includes a fixed spread added to the benchmark rates. These help investors know the minimum margin they will receive over the reference rate. 

Advantages and Disadvantages of Floating Rate Bonds   

The table below shows the advantages and disadvantages of floating-rate bonds. 

Who Should Consider Floating Rate Bonds for Investing? 

The floating rate bonds can be a suitable option for investors who are looking for returns that move with the changing interest rates rather than staying fixed. They might work well for people who are expecting the interest rates to rise as the bond coupon adjusts based on the market benchmarks. These bonds may also fit investors who prefer moderate risk and want protection from interest rate fluctuations that affect traditional fixed-rate bonds. Overall, they can be a good option for individuals seeking more stable purchasing power and market-linked income without taking on high levels of credit risk. 

Conclusion 

Floating rate bonds aim to provide investors with a way to earn interest that adjusts to the market conditions, making them a practical choice when interest rates are expected to rise. These bonds can help reduce interest rate risk, provide market-linked income, and offer multiple options based on issuer and benchmark type. While they may deliver lower income when rates fall, they remain useful for investors looking for flexibility and moderate risk. By evaluating these features through a reliable online trading app, investors may select floating rate bonds depending on their goals and risk comfort.