FLOATING RATE NOTES (FRN)
Floating rate notes (FRNs) are an instrument created after the high volatility of the late 1980s. Interests in this kind of bonds are linked to a specific market rate (e.g., government bonds, or labour rate or other indexes) and are periodically rectified according to the market rates’ evolution. Coupons are obviously not fixed, so they will vary over time. For instance, in the euro area these bonds are often linked to the Euribor parameter (3 month, or 6 month, or 12 month rates, for instance), plus/minus a margin according to the quality of the issuer of the bond.
If the underlying parameter increases over time, obviously we will have progressively higher coupons until the end of the note. The contrary holds.
The duration of floating rate notes is approximately equal to zero, and their price is affected only marginally by changes in the interest rate curve: coupons automatically reflect these changes (the frequency of this adaptation depends on the frequency of payments, i.e. monthly, quarterly, and so on). This is the reason why FRNs are less risky than fixed rate notes (at maturity, issuer and seniority profile are the same).
The global yield of FRNs cannot be defined before their maturity. The evaluation procedure is the same as the one generally adopted for fixed rate notes: the goal is to find the discount rate that makes the cash flows come out of the coupons, and that of the capital redemption (bullet or amortizing) that is equal to the capital invested. But since coupons are unknown, we can define the yield of FRNs only ex post.
Editor: Ugo TRENTA
© 2009 ASSONEBB