What Are Floating Rate Bonds? How Do They Work?

Bonds are debt securities issued in order to raise money. The issuer of bonds can be either banks, corporates or the government. By floating or issuing bonds, the issuer borrows capital at a fixed or variable rate for a specified term. So, the bonds are either fixed-rate bonds or variable/floating rate bonds. Here below we will discuss about floating rate bonds and how do they work.

What Are Floating Rate Bonds? How Do They Work?

What are floating rate bonds?

Floating rate bonds as the name suggests carry variable coupon rate meaning that the interest rate on them changes based on the benchmark rate that is reset periodically. Simply put, interest rate on such floating rate bonds keeps varying throughout its term. In India, the rate on floating rate bonds is bench-marked to repo or reverse repo rate.

For better clarity on floating rate bonds, you can compare it to the floating rate home loan. As in a floating rate home loan, with the increase in the repo rate, you are required to pay a higher EMI and interest rate and viceversa, similar is the scenario with these bonds. That said an investor can either benefit or lose due to any changes in the coupon rates.

Usually, interest on such bonds is paid quarterly, half-yearly or annually as per the terms of the bond.

How Do Floating Rate Bonds Work?

For usual bonds, whenever interest rates are hiked, there is a fall in bond price and the bond yield trends higher. But in case of floating rate bonds that carry variable coupon, the rates are aligned to the market rate. So, whenever interest rate rise, only its coupon rate increases without any correction in bond prices, giving better returns to investors. Likewise, when the interest rate trends lower, the coupon rates also fall, resulting in lower yield to investors.

So, investors can consider investing in these floating rate bonds when the interest rate are low and are on course to rise in the future.

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