======Floating-Rate Note (FRN)======
A Floating-Rate Note (FRN), also known as a "floater," is a type of [[bond]] or other [[debt security]] with a variable interest rate. Unlike a traditional [[fixed-rate bond]] that pays the same [[coupon]] (interest payment) year after year, an FRN’s coupon adjusts periodically. This adjustment isn't random; it's tied to an underlying benchmark [[interest rate]], such as the [[SOFR]] (Secured Overnight Financing Rate) in the U.S. or [[EURIBOR]] in Europe. The issuer pays the investor this benchmark rate plus an additional, fixed percentage known as the [[spread]]. This spread is the investor's reward for taking on the issuer's [[credit risk]]—the risk that the company or government might fail to pay them back. Think of it as a defense mechanism for your bond portfolio: when interest rates in the wider economy rise, the income you receive from your FRN also rises, helping to protect the bond's value.
===== How Do FRNs Actually Work? =====
At its heart, a floater is a simple promise to pay interest that moves with the market. But the devil, as always, is in the details. Understanding these mechanics is key to seeing if FRNs have a place in your portfolio.
==== The Anatomy of an FRN Coupon ====
The interest you earn from an FRN is calculated using a straightforward formula:
**Coupon Rate = Benchmark Rate + Spread**
Let's break this down with an example. Imagine you buy an FRN issued by a corporation. The terms state that the coupon will reset every three months and is based on the SOFR rate plus a spread of 1.5% (also expressed as 150 [[basis points]]).
If, at the beginning of a quarter, SOFR is at 3.0%, your coupon for that period will be:
3.0% (SOFR) + 1.5% (Spread) = 4.5% (annualized rate for that quarter)
If, three months later, SOFR has risen to 3.5%, your next coupon payment will be recalculated and will rise to 5.0%. This "reset" feature is what keeps the FRN in sync with prevailing interest rates.
==== Caps, Floors, and Collars ====
To manage the uncertainty of floating rates, some FRNs come with built-in protections for both the issuer and the investor:
  * **Cap:** This is a maximum interest rate the FRN can pay. It protects the issuer from having to make cripplingly high interest payments if rates skyrocket.
  * **Floor:** This is a minimum interest rate the FRN will pay, regardless of how low the benchmark rate falls. It protects the investor's income in a low-rate environment.
  * **Collar:** This is simply a combination of a cap and a floor, creating a predefined range within which the coupon can float.
===== Why Would a Value Investor Care About FRNs? =====
Value investors are typically focused on buying stocks for less than their intrinsic worth, but the principles of capital preservation and risk management apply just as much to the bond portion of a portfolio.
==== Hedging Against Rising Interest Rates ====
This is the superstar feature of an FRN. A fundamental rule of bonds is that when interest rates rise, the prices of existing fixed-rate bonds fall. This is known as [[interest rate risk]]. Why would anyone pay full price for your old 3% bond when new ones are being issued at 5%?
FRNs largely sidestep this problem. Because their coupon payments rise along with benchmark rates, they remain attractive relative to newly issued debt. As a result, their market price tends to stay much more stable, hovering close to their [[par value]] (the face value of the bond). For an investor focused on preserving capital, this stability during a period of rising rates is incredibly valuable.
==== A Note on Credit Risk ====
//It is crucial to remember this//: FRNs mitigate interest rate risk, but they do **not** eliminate credit risk (also called [[default risk]]). The stability of an FRN's price is still entirely dependent on the financial health of the issuer. If the market starts to worry that the issuing company might go bankrupt, the price of its FRNs will fall, regardless of what interest rates are doing.
A savvy value investor must still perform their [[due diligence]] on the issuer's balance sheet and business prospects. The spread itself is a clue; a very wide spread suggests the market demands a hefty premium to compensate for higher perceived credit risk.
===== The Downside: What's the Catch? =====
FRNs aren't a free lunch. Their defensive nature in one environment becomes a weakness in another.
==== The Flip Side: Falling Rates ====
If you expect interest rates to fall, an FRN is one of the last things you'd want to own. As the benchmark rate drops, so does your income. In this scenario, an investor holding a long-term, high-quality fixed-rate bond would look like a genius, having locked in a high coupon rate for years to come while the FRN holder's income dwindles with each reset.
==== Complexity and Potential Illiquidity ====
While the concept is simple, the specifics of some FRNs—particularly corporate ones with unusual reset dates, multiple benchmarks, or call features—can be complex. Furthermore, the market for some FRNs may be less liquid than for standard government or corporate bonds, meaning it could be harder to sell your position quickly without accepting a lower price.