NationMaster - Encyclopedia: Floating rate note

Floating rate notes (FRNs) are bonds that have a variable coupon, equal to a money market reference rate, like LIBOR or federal funds rate, plus a spread. The spread is a rate that remains constant. Almost all FRNs have quarterly coupons, i.e. they pay out interest every three months, though counter examples do exist. At the beginning of each coupon period, the coupon is calculated by taking the fixing of the reference rate for that day and adding the spread. A typical coupon would look like 3 months USD LIBOR +0.20%. In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and is obliged to repay the principal and interest (the coupon) at a later date, termed maturity. ... In finance, coupons are attached to bonds, either physically, as with old bonds (with a stapler), or electronically. ... This article is about short-term financing. ... A reference rate is any publicly available quoted number or value that is used by the parties to a financial contract. ... LIBOR stands for the London Interbank Offered Rate and is a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the London wholesale (or interbank) money market. ... The federal funds rate is the interest rate at which private depository institutions lend balances (federal funds) at the Federal Reserve to other depository institutions overnight. ... A reference rate is any publicly available quoted number or value that is used by the parties to a financial contract. ...

Issuers

In the U.S., government sponsored enterprises (GSEs) such as the Federal Home Loan Banks, the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) are important issuers. In Europe the main issuers are banks. Motto: (Out Of Many, One) (traditional) In God We Trust (1956 to date) Anthem: The Star-Spangled Banner Capital Washington D.C. Largest city New York City None at federal level (English de facto) Government Federal constitutional republic - President George Walker Bush (R) - Vice President Dick Cheney (R) Independence from... The government sponsored enterprises (GSEs) are a group of financial services corporations created by the United States Congress. ... The Federal Home Loan Banks provide stable, on-demand, low-cost funding to American financial institutions for home mortgage loans, small business, rural, agricultural, and economic development lending. ... The Federal National Mortgage Association (FNMA) (NYSE: FNM), commonly known as Fannie Mae, is a government sponsored enterprise (GSE) sponsored by the United States government. ... The Federal Home Loan Mortgage Corporation (FHLMC) NYSE: FRE, commonly known as Freddie Mac, is a government sponsored enterprise (GSE) sponsored by the United States Government. ... â€œBankerâ€ redirects here. ...

Variations

Some FRNs have special features such as maximum or minimum coupons, called capped FRNs and floored FRNs. Those with both minimum and maximum coupons are called collared FRNs.

FRNs can also be obtained synthetically by the combination of a fixed rate bond and an interest rate swap. This combination is known as an Asset Swap. In finance, a Fixed rate bond is a security issued by a government or a business corporation that pays a fixed amount of interest (coupon rate) on the face value (principal/par value) of the bond periodically (often every six months or annually) to the owner until a date certain... In the field of derivatives, a popular form of swap is the interest rate swap, in which one party exchanges a stream of interest for another partys stream. ...

Risk

FRNs carry little interest rate risk. If market rates rise, a fixed rate bond declines in value. However, the expected coupons of the FRN increase in line with the increase in forward rates. This means the price remains constant. As FRNs are almost immune to interest rate risk, they are considered conservative investments for investors who believe market rates will increase. The risk that remains is credit risk. Interest rate risk is the risk that the relative value of a security, especially a bond, will worsen due to an interest rate increase. ... In finance, a Fixed rate bond is a security issued by a government or a business corporation that pays a fixed amount of interest (coupon rate) on the face value (principal/par value) of the bond periodically (often every six months or annually) to the owner until a date certain... Credit risk is the risk of loss due to a debtors non-payment of a loan or other line of credit (either the principal or interest (coupon) or both). ...

Trading

Securities dealers make markets in FRNs. They are traded over-the-counter, instead of on a stock exchange. In Europe, most FRNs are liquid, as the biggest investors are banks. In the US, FRNs are mostly held to maturity, so the markets aren't as liquid. In the wholesale markets, FRNs are typically quoted as a spread over the reference rate. Over-the-counter (OTC) trading is to trade financial instruments such as stocks, bonds, or derivatives directly between two parties. ... A reference rate is any publicly available quoted number or value that is used by the parties to a financial contract. ...

Trading example

Suppose a new 5 year FRN pays a coupon of 3 months LIBOR +0.20%, and is issued at par (100.00). If the perception of the credit-worthiness of the issuer goes down, investors will demand a higher interest rate, say LIBOR +0.25%. Therefore, a dealer would then make a market of 27 / 25. This means, that he would buy bonds at the equivalent of LIBOR +0.27%, and sell at the equivalent of LIBOR +0.25%. If a trade is agreed, the price is calculated. In this example, LIBOR +0.27% would be roughly equivalent to a price of 99.65. This can be calculated as par, minus the difference between the coupon and the price that was agreed (0.07%), multiplied by the maturity (5 year).

Links

See also

An auction rate security (ARS) typically refers to a debt instrument (corporate or municipal bonds) with a long-term nominal maturity for which the interest rate is reset through a dutch auction. ... In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and is obliged to repay the principal and interest (the coupon) at a later date, termed maturity. ... In finance, a Fixed rate bond is a security issued by a government or a business corporation that pays a fixed amount of interest (coupon rate) on the face value (principal/par value) of the bond periodically (often every six months or annually) to the owner until a date certain... Financial instruments package financial capital in readily tradeable forms - they do not exist outside the context of the financial markets. ...

Category: Bonds The bond market, also known as the debit, credit, or fixed income market, is a financial market where participants buy and sell debt securities usually in the form of bonds. ... This article does not cite any references or sources. ... In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and is obliged to repay the principal and interest (the coupon) at a later date, termed maturity. ... In finance, a debenture is a long-term debt instrument used by governments and large companies to obtain funds. ... A government bond is a bond issued by a national government denominated in the countrys own currency. ... A sovereign bond is a bond issued by a national government. ... Agency debt (sometimes referred to in plural as Agencies) is a type of bond issued by a corporation that is nominally independent of the government - though ownership may be public or private - but considered to be backed by the government, usually on a de facto basis. ... In the United States, a municipal bond or muni is a bond issued by a state, city or other local government, or their agencies. ... A corporate bond is a bond issued by a corporation. ... Emerging Market Debt (EMD) is a term used to encompass bonds issued by less developed countries. ... In finance, a Fixed rate bond is a security issued by a government or a business corporation that pays a fixed amount of interest (coupon rate) on the face value (principal/par value) of the bond periodically (often every six months or annually) to the owner until a date certain... Zero coupon bonds are bonds which do not pay periodic coupons, or so-called interest payments. ... Inflation-indexed bonds (also known as linkers) are bonds whose principal are indexed to inflation, cutting out inflation risk. ... Commercial paper is a money market security issued by large banks and corporations. ... An accrual bond is a fixed-interest bond that is issued at its face value and repaid at the end of the maturity period together with the accrued interest. ... An auction rate security (ARS) typically refers to a debt instrument (corporate or municipal bonds) with a long-term nominal maturity for which the interest rate is reset through a dutch auction. ... To meet Wikipedias quality standards, this article or section may require cleanup. ... A convertible bond, or convertible debenture, is a type of bond that can be converted into shares of stock in the issuing company, usually at some pre-announced ratio. ... A mortgage-backed security (MBS) is an asset-backed security whose cash flows are backed by the principal and interest payments of a set of mortgage loans. ... An asset-backed security is a type of bond or note that is based on pools of assets, or collateralized by the cash flows from a specified pool of underlying assets. ... A bond option is similar to a stock option with the difference that the underlying asset is a bond. ... // A credit derivative is a financial instrument or derivative (finance) whose price and value derives from the creditworthiness of the obligations of a third party, which is isolated and traded. ... A credit default swap (CDS) is a bilateral contract under which two counterparties agree to isolate and separately trade the credit risk of (at least one) third party entity. ... Collateralized debt obligations (CDOs) are a type of asset-backed security or structured finance product. ... A Collateralized Mortgage Obligation (CMO) is a type of Mortgage Backed Security, which has been divided up into tranches. ... Bond valuation is the process of determining the fair price of a bond. ... Par value has several meanings depending on the context, whether used in the equities market, or in the bond markets, and partially also dependent on where in the world the par value term is used. ... In finance, coupons are attached to bonds, either physically, as with old bonds (with a stapler), or electronically. ... The price quoted for a bond excluding accrued interest. ... Dirty Price A bond price that includes accrued interest. ... In finance, accrued interest is the interest that has accumulated since the principal investment, or since the previous interest payment if there has been one already. ... It has been suggested that Interest rate basis be merged into this article or section. ... Nominal yield is the income received from a fixed income security in one year divided by its par value. ... This article or section does not cite its references or sources. ... Yield to maturity (YTM) is the yield promised by the bondholder on the assumption that the bond will be held to maturity, that all coupon and principal payments will be made and coupon payments are reinvested at the bonds promised yield at the same rate as invested. ... The US dollar yield curve as of 9 February 2005. ... In economics and finance, duration is the weighted average maturity of a bonds cash flows or of any series of linked cash flows. ... This article does not cite any references or sources. ... Credit analysis is the method by which one calculates the creditworthiness of a company according to the numbers made available by the audited financials for the financial year. ... Credit risk is the risk of loss due to a debtors non-payment of a loan or other line of credit (either the principal or interest (coupon) or both). ... In finance the Yield spread is the difference between the quoted rates of return on two different investments; a way of comparing any two financial products. ... Credit spread is the difference in yield between different securities due to different credit quality. ... Option adjusted spread (OAS) is the flat spread over the treasury yield curve required to discount a mortgage-backed securitys volatile coupon payments to match its market price. ... In the context of interest rate derivatives, a short rate model is a mathematical model that describes the future evolution of interest rates by describing the future evolution of the short rate. ... The Rendleman-Bartter model in finance is a short rate model describing the evolution of interest ratess. ... In finance, the Vasicek model is a mathematical model describing the evolution of interest rates. ... In financial mathematics, the Ho-Lee model is a Short rate model of future interest rates. ... In financial mathematics, the Hull-White model is a model of future interest rates. ... The Cox-Ingersoll-Ross model in finance is a mathematical model describing the evolution of interest rates. ... [edit] The model The first stochastic mean and stochastic volatility model was described by Lin Chen in 1996. ... Heath-Jarrow-Morton framework is a general framework to model the evolution of interest rates (forward rates in particular). ... Black-Derman-Toy, or BDT, in finance, is a model of the evolution of the yield curve, sometimes referred to as an short rate model. ...

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