Floating Rate Note
Also known as: FRN, Floater
A bond whose coupon resets with the market — interest-rate risk engineered out, credit risk left in.
1 · SnapshotThe one idea to remember
2 · BeginnerWhat is it, really?
A floating rate note pays interest that resets periodically to a market benchmark — today typically an overnight-rate index like SOFR or €STR — plus a fixed margin. If rates rise, your next coupon rises with them; if rates fall, it falls.
That reset is the product's superpower: because coupons continually catch up with the market, the price barely moves when interest rates change. Rate risk, the thing that batters ordinary bonds, is largely engineered away.
What remains is credit risk: the issuer still has to pay. An FRN from a shaky borrower will fall in price when its spread widens, floating coupon or not. Investors buy FRNs to sit out rate turbulence while still earning issuer spread.
a paymentnot a payment
The same shape as a plain bond, with one arrow replaced by a measurement — and that is why the price barely moves when rates do.
At issue
- The investor → The issuer You lend, as with any bond. The spread over the index is fixed here and stays fixed.
At the start of each period
- The reference rate → The issuer The coupon for the coming period is set from the published index, plus the agreed spread. Nobody negotiates it.
At the end of each period
- The issuer → The investor Because the coupon re-prices with the market, the note's price stays near par. The investor's risk is the issuer's credit, not the level of rates.
At maturity
- The issuer → The investor Unchanged by anything the index did along the way.
- Asset class
- Fixed income
- Instrument type
- Floating-coupon bond
- Traded
- OTC
- Typical users
- Banks, money funds, rate-hike hedgers
Which risks decide the outcome
Not how risky this is, and not a rating — there is deliberately no total. It says which of five failure modes drives what happens here, in the same order on all 129 products so they can be compared. This publication's own reading; see the notice below.
- Marketmatters
- Creditdecides it
- Liquiditymatters
- Fundingbarely applies
- Operationalbarely applies
What decides it here. The coupon re-prices with the market, so the price stays near par and the level of rates stops mattering. What is left is whether the issuer pays.
3 · IntermediateHow it works in practice
Coupon mechanics
- Formula: reference rate (e.g. compounded SOFR over the period) + quoted margin (fixed at issue, say +80bp).
- Reset frequency: usually quarterly; the coupon is known either at the period's start (legacy IBOR-style) or, for compounded overnight rates, only at its end.
- Floors: many FRNs floor the coupon (often at 0%) — a small embedded option that gains value when rates approach zero.
Why prices still move
Between resets, small rate sensitivity exists (duration ≈ time to next reset — weeks, not years). The real driver is the discount margin: the market's current required spread. Quoted margin 80bp but market now demands 120bp? The price drops below par so a buyer effectively earns the extra 40bp.
Who issues and who buys
Banks are the dominant issuers (matching their floating-rate assets); governments issue some (US Treasury FRNs). Buyers: money market funds, corporate treasuries and anyone bracing for hikes — FRN fund inflows are a classic rising-rate trade.
4 · AdvancedPricing & valuation
The par-at-reset theorem
A default-free floater paying exactly the discount rate resets to par at every coupon date: discounting rate-matched cash flows at that same rate telescopes to 100. Real FRNs deviate from par only through (a) the gap between quoted margin \(m\) and current required margin \(\bar{m}\), and (b) accrual within the period:
What the symbols mean
- Pa price, or a present value
- ta point in time
- deltaa small change in whatever follows
- rthe interest rate, per year
— the price is par plus the annuity value of the margin differential. Solving this for \(\bar{m}\) given price defines the discount margin, the FRN market's YTM-equivalent.
Risk decomposition
- Rate duration ≈ time to next reset (near zero) — but only for the index component.
- Spread duration ≈ that of a fixed bond of the same maturity: the margin differential annuity is a long-dated exposure. An FRN is short-duration in rates, long-duration in credit.
Post-IBOR conventions
Modern FRNs compound the overnight rate in arrears: coupon \(= \big[\prod_d (1 + r_d \tfrac{n_d}{360}) - 1\big]\tfrac{360}{N} + m\), with lookbacks/lockouts for payment operational lag. Valuation is straightforward on an OIS curve since projection and discounting use the same index — the basis complexity that plagued IBOR floaters largely dissolved.
Embedded floors
A floored FRN = plain FRN + strip of floorlets on the index; in low-rate regimes the floor can dominate returns and gives the "floater" genuine positive duration — priced with the cap/floor machinery (Bachelier quotes on the compounded index).
The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.
5 · Desk notesHow practitioners think about it
Now say it back
Close the page and give Floating Rate Note in four sentences. It takes a minute and it is the only way to find out whether reading it was enough.
- Who wants what — two parties wanted opposite things badly enough to write it down.
- What the contract obliges, and when — not the payoff; the obligation.
- Where the money comes from — name the source, or you have described a hope.
- What makes it lose — the ordinary way, not the dramatic one.
Put Floating Rate Note beside any other instrument →
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