Corporate Bonds

Posts Tagged ‘floating rate notes’

Risks of Floating Rate Notes #1: Interest Rate Risk

While the market value of Floating Rate Notes or floaters are relatively insensitive to changes in interest rates, the income received are, highly dependent upon the level of the reference rate over the life of the Floating Rate Notes investment.

Total return of Floating Rate Notes may be less than anticipated if future interest rate expectations are not met.

Risks of Floating Rate Notes #2: Credit Risk

Credit risk involves the scenario in which the issuer will be unable to meet its payment obligations.

Credit ratings serve as a measure of the issuer's financial health and should be taken into account when considering a purchase of floaters.

In addition, because the spread paid in excess of the reference rate is determined in part by the issuer's credit rating, changes in this credit rating can also affect the market value of the investment.

Risks of Floating Rate Notes #3: Call Risk

If a callable floater is called by the issuer prior to maturity, the investor may be unable to reinvest funds in another floater with comparable terms.

If the floater is not called, the investor should be prepared to hold it until maturity.

What are the benefits of Floating Rate Notes or floater?

Value in a Rising Interest Rate Environment

An investor who believes interest rates are on the rise may not want to commit to a current fixed rate for the long term investment.

Conversely, short term inertness rates may also not meet an investor's expectations.

Floating Rate Notes or floaters offer an ideal alternative as they generally pay a spread above current short term interest rates as well as offer the benefit of future increases in the benchmark.

If interest rates rise for example, the investor will receive a coupon payment higher then the original coupon.

Manage Interest Rate Risk

While a fixed rate corporate bond will trade down in price as interest rates rise, a floating rate bond tied to interest rates typically does not react as strongly to interest rate variations because the coupon changes in sync with interest rates.

As a result, Floating Rate Notes or floaters will not appreciate as much as fixed rate bonds in a declining interest rate environment, however, in a rising interest rate environment should out perform fixed rate Corporate Bonds.

Floating Rate Notes or floaters give investment variety

Floating Rate Notes or Floaters are available in a variety of maturities, issuers, credit quality and coupons. Therefore, they give investment variety for diversification.