FRN: Floating-Rate Note

Floating-Rate Notes (FRNs) are a type of bond characterized by variable interest rates. These financial instruments are critical in the realm of investments due to their adaptability to changing interest rates.

Government FRNs

Issued by governments, these are considered low-risk investments. Examples include the U.S. Treasury FRNs, which have maturities of 2 years and interest rates tied to the 13-week Treasury bill rate.

Corporate FRNs

Issued by corporations, these carry higher risk compared to government FRNs due to default risk. Interest rates are often linked to benchmarks like the LIBOR or EURIBOR.

Structured FRNs

These notes have complex features, such as caps, floors, or call and put options, which can affect the interest rates and payments.

Key Events in the History of FRNs

• 1970s: Introduction of the first FRNs.
• 2008 Financial Crisis: Increased issuance of FRNs as companies sought flexible financing options.
• 2021 Transition from LIBOR: Shift towards alternative benchmarks like SOFR (Secured Overnight Financing Rate).

Detailed Explanation

FRNs offer interest payments that are reset periodically, typically every three or six months. The interest rate is calculated based on a benchmark rate plus a spread. This mechanism provides protection against rising interest rates, making them attractive during periods of rate volatility.

Mathematical Models

The formula to calculate the interest payment on an FRN is:

Example Calculation

If the benchmark rate is 2%, the spread is 0.5%, and the face value is $1,000:

Importance

FRNs are crucial for both issuers and investors:

• Issuers: Benefit from lower initial interest payments and reduced interest rate risk.
• Investors: Attractive due to their ability to offer protection against rising interest rates.

Pros

• Protection against interest rate increases.
• Potentially higher returns during rate hikes.

Cons

• Complexity and risk of interest rate resets.
• Lower initial returns compared to fixed-rate bonds.

Related Terms

• Fixed-Rate Bond: A bond with a set interest rate throughout its life.
• LIBOR: A benchmark rate formerly used to set interest rates for FRNs.
• SOFR: A replacement for LIBOR as a benchmark rate.

What is an FRN?

An FRN is a bond with a variable interest rate.

How is the interest rate on an FRN determined?

It is based on a benchmark rate plus a spread.

Why are FRNs important?

They offer protection against rising interest rates, making them valuable in volatile markets.