A floating-rate note (FRN) is a type of debt security with a variable interest rate that adjusts periodically based on a benchmark rate, such as LIBOR. Unlike fixed-rate bonds, which offer a constant coupon payment, FRNs have interest payments that fluctuate in response to changes in market rates. 

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What Is a Floating-Rate Note (FRN)?

A floating-rate note is a debt instrument carrying a coupon rate that moves with some benchmark rate, causing the coupon rate to be variable in nature over time. The normal calculation of the coupon is the variable benchmark rate plus a fixed spread. The interest rate is typically adjusted on a monthly or quarterly basis according to the benchmark. Basically, the maturity period of FRNs varied and was within a range from one to five years.

FRNs are generally issued by governments, private companies, as well as financial institutions, and they are usually over the counter traded. Since FRNs are fixed income securities, they usually pay coupons based on a reference rate that is reset after some time, which leads to fluctuating payments over time. An investor is likely to acquire FRNs if interest rates continue to go up, as the variable payments will act as a hedge for rising rates.

An example of a floating rate note (FRN) could be a corporate FRN issued by a company, say Company ABC, with the following characteristics:

• Issuer: Company ABC
• Benchmark Rate: LIBOR (London Interbank Offered Rate)
• Fixed Spread: 1.5%
• Coupon Rate: The coupon rate is determined by adding the fixed spread to the benchmark rate. For instance, if LIBOR is 2.0%, the coupon rate would be 3.5% (2.0% + 1.5%).
• Payment Frequency: Quarterly
• Maturity Period: 3 years
• Face Value: $1,000

In this scenario, if LIBOR increases to 2.5% in the next reset period, the new coupon rate would be 4.0% (2.5% + 1.5%), and the interest payment received by the bondholder would adjust accordingly. Conversely, if LIBOR decreases to 1.5%, the coupon rate would drop to 3.0% (1.5% + 1.5%), leading to a lower interest payment. This variability in payments makes FRNs appealing to investors during periods of rising interest rates.

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Callable Floating Rate Note vs. Non-Callable Floating Rate Note

Here’s a comparison between callable floating rate notes (FRNs) and non-callable floating rate notes:

Callable Floating Rate Note

• Definition: A callable floating rate note allows the issuer to redeem the bond before its maturity date at specified times.
• Investor Risk: Higher risk for investors since the issuer may call the note when interest rates decline, forcing investors to reinvest at lower rates.
• Yield: Typically offers a higher yield compared to non-callable FRNs to compensate for the additional risk of early redemption.
• Flexibility for Issuers: Provides issuers with the flexibility to manage their debt and interest expenses based on changing market conditions.
• Example: A company issues a callable FRN that can be redeemed after two years if market interest rates fall below the note’s coupon rate.

Non-Callable Floating Rate Note

• Definition: A non-callable floating rate note cannot be redeemed by the issuer before its maturity date, ensuring that investors receive interest payments for the entire term.
• Investor Risk: Lower risk for investors as they are assured of holding the investment until maturity without the concern of early redemption.
• Yield: Generally offers a lower yield compared to callable FRNs, as investors are not exposed to the same level of reinvestment risk.
• Stability for Investors: Provides more predictability for cash flows and allows investors to plan their investments without the uncertainty of early redemption.
• Example: A government issues a non-callable FRN with a 5-year maturity that guarantees interest payments for the full term.

Bottom line

Floating-rate notes offer a dynamic investment opportunity with interest payments that adjust according to market benchmarks. Whether issued as callable or non-callable, FRNs cater to investors seeking to benefit from rising rates while managing interest rate risk. For those looking for a stable and attractive return in a fluctuating rate environment, Compound Real Estate Bonds offer a compelling alternative. With a high yield of 8.5% APY, backed by real estate and U.S. Treasuries, these bonds combine the stability of fixed income with the flexibility of modern financial solutions, making them a worthy consideration for a diversified investment strategy.

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