Floating Rate Note (FRN)
Candlefocus EditorUnlike fixed-rate bonds that have a single fixed interest rate, FRNs are adjustable securities that offer a variable rate of return. The interest rate on the security is set periodically, for instance quarterly, and adjusted as the benchmark rate changes. The rate that the investor receives is determined by the benchmark rate – usually LIBOR or the Federal Funds rate – plus a pre-set margin. This spread or margin remains constant throughout the term of the floating rate note.
By investing in FRNs, investors can take advantage of the fluctuating market interest rates without holding a large number of different floating rate notes to diversify their portfolio. Furthermore, due to the relatively short maturities of FRNs, investors can remain Liquid and more easily adjust their more volatile investments as opposed to long-term fixed rate securities.
While floating rate notes offer more liquidity and the opportunity to benefit from short-term movements in the benchmark rate, they are not without risk. Even though the interest rate on a FRN may fluctuate, in times of prolonged low interest rates, investors may find that the returns that they expect to receive are significantly lower than those offered by fixed rate notes. This is because the return on a FRN is generally capped at the spread or margin that was put on the note.
In conclusion, while they can offer potential benefits to investors, floating rate notes also bring with them some risk. Investors should weigh the advantages and disadvantages of investing in FRNs in order to make an informed decision about the venture.