Floating Rate Notes Valuation Practical Guide

A floating rate note has variable coupons, depending on a money market reference rate, such as LIBOR, plus a floating spread. When interest rate raises, the coupons of an FRN increases in line with the increase of the forward rates, which means its price remains relatively constant. Therefore, FRNs bear small interest rate risk. On the other hand, FRNs carry lower yields than fixed rate bonds of the same maturity. They also have unpredictable coupon payments.

The price of an FRN has very low sensitivity to changes in interest rates because the floating coupon increases but the discounting also increases as interest rate rises. An investor who wants conservative investments may choose floating rate bonds. FRNs become more popular when interest rates are expected to increase. An FRN carry lower yield than fixed rate bonds of the same maturity and has unpredictable coupon payments. This presentation gives an overview of FRNs valuation.