Floating-rate notes coupon rates

A fixed-rate bond pays fixed coupons during the bond s life known with certainty. Conversely, a floating-rate note ox floater pays variable coupons linked to a reference rate. This makes the coupon payments uncertain. The main pim-pose of this debt instrument is to hedge the risk of rising interest rates. Although the financial crisis and liquidity provided by central banks have decreased the level of interest rates, they will at some point of course rise in future years. 

The authors find that conversely to the price of a fixed-rate coupon payment, which is a decreasing function of the maturity T, with floating-rate notes, the value depends on the level of interest rates. In fact, when the interest rate is below the long-run average value, the increase of T reduces the value of the floater and vice versa. In addition, the price of a floating-rate note increases with rising risk-free interest rates. 

The pricing of a floating-rate note at issue does not differ from a conventional bond. In fact, it is the present value of coupon payments and principal repayment and is given by (10.3) ... 

Another approach is to compare the floating-rate note with a derived yield of a fixed-rate bond by using an interest rate swap curve matched with floater coupons. Figure 10.4 shows the Bloomberg YASN screen for Mediobanca float... 

Floating-rate notes can include additional features. One example is the inclusion of cap, floor and collar clauses. A floater with cap feature means that the reference rate cannot overcome the threshold rate defined in the indenture. Usually the threshold is expressed in terms of coupon, that is after a coupon threshold (e.g. 6%, reference rate plus quoted margin) the investor receives at maximum the cap level. In this case, the floater is not completely covered by rising interest rates, in which after the threshold the floater trades as a conventional bond. In contrast, a floater with a floor feature represents the minimum coupon level that an investor can receive, hedging to the downside risk of interest rates. If the bond includes both cap and floor, this feature is known as collar or collared floating-rate note. The bond can include also a drop-lock feature that after a threshold it ceases to float. 

An inverse floating-rate note pays coupons that increase if the reference rate decreases. Therefore, this bond gives a benefit at investors with a negative yield curve. The coupon structure of inverse floaters usually is determined as a fixed interest rate less a variable interest rate linked to a reference index. Moreover, they can include floor provisimis. 

An index-linked bond has its coupon or maturity value or sometimes both linked to a specific index. When governments issue index-linked bonds, the cash flows are linked to a price index such as consumer or commodity prices. Corporations have also issued index-linked bonds that are connected to either an inflation index or a stock market index. For example, Kredit Fuer Wiederaufbau, a special purpose bank in Denmark, issued a floating-rate note in March 2003 whose coupon rate will be linked to the Eurozone CPI (excluding tobacco) beginning in September 2004. Inflation-indexed bonds are detailed in Chapter 8. 

Floating-rate notes (FRNs) are Eurobonds that have their coupon levels reset periodically, with reference to a money market rate. For dollar-denominated assets, this is LIBOR (the London Inter-bank Offer Rate) as determined by a group of 16 reference banks. The mechanism is run by the British Bankers Association (BBA). The BBA also supervises LIBOR fixings in a number of other currencies. For euros, the most common reference rate is EURIBOR, as determined by a reference group of around 50 banks chosen by European Banking Federation. In both cases, most issues are priced off of the three-month rate, although one-month and six-month rates are also used. 

Current pt. Current-pay bonds have been issued in Turkey. They are similar to interest-indexed bonds in that their redemption payments at maturity are not adjusted for inflation. They differ, however, in their term cash flows. Current-pay bonds pay an inflation-adjusted coupon plus an indexed amount that is related to the principal. In effect, they are inflation-indexed floating-rate notes. 

Floating-rate notes, or FRNs, are not structured notes. They are described here as a prelude to a discussion of inverse floating-rate notes, which are structured notes. As explained in chapter 1, an FRN is a bond that has a variable rate of interest the coupon rate is linked to a specified index and changes periodically to reflect the current index reading. The notes usually pay a fixed spread over their reference index—for example, 50 basis points over the 6-month interbank rate. An FRN whose spread over the reference rate is not fixed is known as a variable-rate note. 

An inverse floating-rate note, or inverse floater, pays a coupon that increases as general market rates decline. It offers enhanced returns to investors who, in contrast to the market consensus, believe the outlook for bonds is generally positive. These notes are suitable when inflation is low and the yield curve positive, both conditions that would, in a conventional analysis, suggest rising interest rates in the medium term. Inverse floaters may also be appropriate when the yield curve is negative, i.e., inverted, should the investor agree with the market consensus, which would be for lower rates in the medium term. 

Floating rate notes (FRNs) are bonds that have variable rates of interest the coupon rate is linked to a specified index and changes periodically as the index changes. An FRN is usually issued with a coupon that pays a fixed spread over a reference index for example, the coupon may be 50 basis points over the six-month interbank rate. Since the value for the reference benchmark index is not known, it is not possible to calculate the redemption yield for an FRN. The FRN market in countries such as the United States and United Kingdom is large and well-developed floating-rate bonds are particularly popular with short-term investors and financial institutions such as banks. 

Floating-rate bonds, often referred to as floating-rate notes (FRNs), also exist. The coupon rates of these bonds are reset periodically according to a predetermined benchmark, such as 3-month or 6-month LIBOR (London interbank offered rate). LIBOR is the official benchmark rate at which commercial banks will lend funds to other banks in the interbank market. It is an average of the offered rates posted by all the main commercial banks, and is reported by the British Bankers Association at 11.00 hours each business day. For this reason, FRNs typically trade more like money market instruments than like conventional bonds. 

Note that the swap PVBP, 425, is lower than that of the 5-year fixed-coupon bond, which is 488.45. This is because the floating-rate bond PVBP reduces the risk exposure of the swap as a whole by 63.45. As a rough rule of thumb, the PVBP of a swap is approximately the same as that of a fixed-rate bond whose term runs from the swaps next coupon reset date through the swap s termination date. Thus, a 10-year swap making semiannual payments has a PVBP close to that of a 9.5-year fixed-rate bond, and a swap with 5.5 years to maturity has a PVBP similar to that of a 5-year bond. 

FRNs can have additional features, such as flbors, which specify minimum levels below which the coupon cannot fall caps, which specify maximum rates and calls, which specify possible redemption dates before maturity. Perpetual FRNs also exist. As in other markets, borrowers frequently issue floating notes with specific, even esoteric, terms to meet particular requirements or customer demands. For example. Citibank issued a series of U.S. dollar—denominated FRNs indexed to the Euribor rate and another set of notes whose day count was linked to a specified LIBOR range. 

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