Floating-rate note

Floating-rate note is a type of coupon bonds, payments on which are variable and are not determined until the end of the instrument’s circulation period. All other characteristics of this type of bonds and their possible types are similar to securities with a fixed coupon.

There are the following types of bonds with floating interest rates:

• Bonds, the coupon of which is tied to the dynamics of the market indicator. The market indicator (bond base rate) is most often used by government bond yields, interbank market rates, macroeconomic indicators and currency swap rates. This type of bonds can be classified in more details depending on the fixing of the base rate.
By the frequency of fixing the base rate, bonds are divided into:
• Bonds, the fixing frequency of which is less frequent than the coupon payment frequency which rate is determined and remains unchanged for several coupon periods. Typically, these are securities linked to mid swaps or sovereign bond yields, and the coupon rate expires in accordance with the urgency of the underlying indicator.
• Bonds, the fixing frequency of which coincides with the coupon payment frequency and is determined one coupon period before the start of the settlement coupon.
• Bonds linked to alternative near-risk-free rates , which are fixed daily, and the final coupon rate is determined only at the end of the coupon period.
By the method of calculating the base rate, there are:
• Bonds with a floating rate with a direct dependence on the movement of the base indicator. The coupon of such securities is determined as the sum of the base rate and a certain premium - margin that depends on the credit quality of the issuer. At the same time the margin can also be negative in case of placement of a foreign issuer with a high credit rating
• Bonds with inverse floating rate. The coupon rate for such securities is calculated as the difference between the fixed value and the base rate.
• Bonds, with the coupon of which is dependent on the price movement of a particular underlying asset. Almost the entire universe of structured products falls into this category. The underlying asset can be virtually any financial asset - a stock, bond, exchange rate, macroeconomic indicator, financial derivative, or a basket of assets of the same or different types.
• Bonds, the coupon of which is dependent on the occurrence or non-occurrence of a particular event. This category can include both structured products (for example credit-linked notes ), and unstructured bonds. Among the most popular events on which the coupon rate change depends are: a change in the issuer’s credit rating, a change in control over the issuer, compliance with a certain norm (this can be both a financial indicator, and an environmental indicator in the case of sustainability-linked bond (sustainability-linked bond).
• Bonds, the coupon for which is determined by the issuer’s decision. Usually, such securities provide for a put option on the coupon date on which the rate change is provided

The main advantage of floating rate bonds for both the issuer and the investor is the ability to improve borrowing conditions for the former or investment conditions for the latter in case of favorable changes in market conditions. Floating coupon bonds are largely insured against high interest rate volatility. As interest rates rise, floating coupon securities do not decline as much in price as fixed coupon securities.

On the other hand, floating rate bond issuance is associated with less predictability of returns for the investor and difficulty in calculating investment results, as well as uncertainty in the cost of debt service for the issuer. The latter increases the risk of default on bonds.