An Introduction to Bond Markets, Fourth Edition

Chapter 4

FLOATING-RATE NOTES AND OTHER BOND INSTRUMENTS

In this chapter we describe floating rate notes (FRN) and how to hedge their issuance.

FLOATING-RATE NOTES

Floating-rate notes (FRNs) are bonds that have variable rates of interest; the coupon rate is linked to a specified index and changes periodically as the index changes. An FRN is usually issued with a coupon that pays a fixed spread over a reference index; for example, the coupon may be 50 basis points over the 6-month interbank rate. An FRN whose spread over the reference rate is not fixed is known as a variable rate note. Since the value for the reference benchmark index is not known, it is not possible to calculate the redemption yield for an FRN. Additional features have been added to FRNs, including floors (the coupon cannot fall below a specified minimum rate), caps (the coupon cannot rise above a maximum rate) and callability. There also exist perpetual FRNs. As in other markets, borrowers frequently issue paper with specific or even esoteric terms in order to meet particular requirements or meet customer demand; for example, Citibank recently issued US dollar-denominated FRNs with interest payments indexed to the euribor rate, and another FRN with its day-count basis linked to a specified London Interbank Offer Rate (Libor) range.

 

Generally, the reference interest rate for FRNs is the Libor rate; the offered rate, that is the rate at which a bank will lend funds to another bank is Libor. An FRN will pay ...