Because their coupons adjust with changes in short-term interest rates, FRNs are often used to help reduce interest rate risk during periods of rising rates.

FRNs typically have two- to five-year maturities. Floating rates allow investors to earn the prevailing market interest rate plus a fixed spread while reducing the risks associated with rising rates. Corporate FRN coupons are adjusted on periodic reset dates determined by the issuer.

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The fixed spread remains constant over the life of the note. Typically, the wider the spread, the riskier the FRN.

Defining the Coupon Rate

Most investment-grade corporate FRNs make coupon payments quarterly, allowing investors to benefit from rising rates relatively quickly. Traditional fixed-rate bond prices are inversely related to interest rate movements—when interest rates rise, bond prices fall, and vice versa. Although FRNs are not completely hedged against interest rate risk, their prices remain relatively stable over time compared to fixed-rate bonds. Most corporate floating rate notes carry an investment-grade credit rating, meaning credit agencies consider these issuers less likely to default on their payments.

Many FRNs are issued with a cap, a floor, or both. A cap determines the maximum interest rate an issuer will pay despite the level interest rates rise.

Conversely, a floor guarantees that the issuer will pay a minimum interest rate, even if the coupon payment calculated by the reference rate is lower. Typically, the best time to invest in FRNs is when short-term interest rates are relatively low and expected to rise.

In a rising rate environment, their variable rate feature makes them ideal for investors focused on capital preservation and keeping pace with inflation. FRNs may also be appropriate for shorter-term cash management solutions.

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The denominator is a factor raised by an exponent. The factor is 1 plus the prevailing interest rate, divided by the number of months in each coupon period, divided by 12 months.

The exponent is the time until the next payment rate, expressed as a fraction of the coupon period. The numerator of the price equation is The denominator is 1 plus 0. The result is a price of Eric Bank is a senior business, finance and real estate writer, freelancing since He has written thousands of articles about business, finance, insurance, real estate, investing, annuities, taxes, credit repair, accounting and student loans.

Eric writes articles, blogs and SEO-friendly website content for dozens of clients worldwide, including get. His website is ericbank. At the center of everything we do is a strong commitment to independent research and sharing its profitable discoveries with investors. When rates go up, bond prices fall. This has been the general consensus amongst investors when faced with the prospect of rising interest rates in the current economic environment.

When nominal rates increase faster than inflation, long duration RRBs will still decrease in price.