Floating Rate Note
A floating-rate note (FRN) is a debt instrument with a variable interest rate. The interest rate for an FRN is tied to a benchmark rate. Benchmarks include the U.S. Treasury note rate, the Federal Reserve funds rate—known as the Fed funds rate—the London Interbank Offered Rate (LIBOR), or the prime rate.Floating rate notes or floaters can be issued by financial institutions, governments, and corporations in maturities of two-to-five years.
Floating Rate Note (FRN)
Definition
A Floating Rate Note (FRN) is a debt instrument with a variable interest rate. The interest rate is tied to a benchmark rate such as the U.S. Treasury rate, the Federal Funds Rate, the London Interbank Offered Rate (LIBOR), or the prime lending rate. The interest rate on an FRN adjusts with changes in these benchmark rates.
Origin
The concept of Floating Rate Notes originated in the 1970s when financial markets sought debt instruments that better reflected changes in market interest rates. As global financial markets evolved, FRNs became an important financing tool widely used by financial institutions, governments, and corporations.
Categories and Characteristics
Floating Rate Notes can be categorized into the following types:
- FRNs issued by financial institutions: Typically issued by banks and other financial institutions to raise short-term funds.
- FRNs issued by governments: Issued by national or local governments, usually for public project financing.
- FRNs issued by corporations: Issued by various corporations to meet operational and expansion funding needs.
The main characteristics of Floating Rate Notes include:
- Variable interest rate: The rate is tied to a benchmark rate, reflecting changes in market interest rates.
- Flexible terms: Usually ranging from 2 to 5 years, suitable for different funding needs.
- Lower risk: Since the interest rate adjusts with the market, investors face lower interest rate risk.
Specific Cases
Case 1: A bank issues a batch of Floating Rate Notes tied to LIBOR, with quarterly adjustments. As market interest rates rise, LIBOR also increases, resulting in higher interest income for investors.
Case 2: A corporation issues a batch of Floating Rate Notes tied to the U.S. Treasury rate. Due to changes in economic conditions, the U.S. Treasury rate decreases, reducing the corporation's financing costs.
Common Questions
Q: How frequently is the interest rate on a Floating Rate Note adjusted?
A: The interest rate on an FRN is typically adjusted quarterly, but the specific frequency may vary based on the issuance terms.
Q: What are the main risks associated with Floating Rate Notes?
A: The main risks include credit risk and market interest rate fluctuation risk, but interest rate risk is relatively low since the rate adjusts with the market.
