Floating Rate Fund

DEFINITION of 'Floating Rate Fund'

A mutual fund that invests in financial instruments with a variable or floating interest rate. A floating rate fund invests in bonds and debt instruments whose coupons fluctuate in line with the underlying level of interest rates, as opposed to fixed-rate coupons. The biggest advantage of a floating rate fund is its lower degree of sensitivity to changes in interest rates compared with a fund or instrument with a fixed coupon rate. Floating rate funds appeal to investors when interest rates are rising, since this will result in a higher level of interest or coupon payments. They are far less appealing when interest rates are declining.

BREAKING DOWN 'Floating Rate Fund'

The coupon rates payable on a floating rate instrument held within a floating rate fund will vary in line with a defined interest rate benchmark known as the reference rate. The reference rate that is used as a basis to adjust the coupon rate is generally a widely followed benchmark such as LIBOR (the London Interbank Offered Rate), the U.S. federal funds rate or the prime rate.

Apart from their lower sensitivity to interest rate changes and ability to reflect current interest rates, a floating rate fund enables an investor to diversify fixed-income investments, since fixed-rate instruments comprise the majority of bond holdings for most investors. Another benefit is that a floating rate fund enables an investor to acquire a diversified bond portfolio at a relatively low investment threshold, since most bonds are only available in large dollar amounts. A floating rate fund may also mitigate credit risk by holding bonds from a number of issuers. This diversified fund portfolio may have a lower degree of credit risk compared to a fixed-income portfolio that only has a couple of issuers.

In evaluating a floating rate fund, investors must ensure that the bonds the fund holds are adequate for their risk tolerance level. For example, an 80-year-old investor whose primary objective is capital preservation would be ill-advised to invest in a floating rate fund that invests primarily in speculative-grade bonds, since it may be susceptible to a higher degree of credit risk and significant price volatility.

RELATED TERMS
  1. Floating Interest Rate

    An interest rate that is allowed to move up and down with the ...
  2. Variable Rate Demand Bond

    A bond with floating coupon payments that are adjusted at specific ...
  3. Float

    Money in the banking system that is briefly counted twice due ...
  4. Floating Stock

    The number of shares available for trading of a particular stock. ...
  5. Availability Float

    The time period between when a deposit is made and when the funds ...
  6. Dirty Float

    A system of floating exchange rates in which the government or ...
Related Articles
  1. Stock Analysis

    Is it Time to Buy Floating Rate Bonds?

    The Fed’s awaited interest rate hike could finally be at hand. Are floating rate bonds the way to go?
  2. Investing Basics

    Calculating Floating Stock

    Floating stock is the number of shares a company has available for trade in the open market.
  3. Professionals

    Basic Coupon Structures

    CFA Level 1 - Basic Coupon Structures. Learn the various coupon structures of bonds. Provides an example of a floating rate bond and discusses how it relates to caps and floors.
  4. Mutual Funds & ETFs

    How Interest Rates Affect Mutual Funds

    Find out how changing interest rates impact mutual funds, including bond and money market funds, and how higher rates can discourage investors.
  5. Investing Basics

    Floating Stock

    Floating stock is the number of a company’s shares that are available for the public to buy and sell.
  6. Investing Basics

    Managing Interest Rate Risk

    Interest rate risk stems from the possibility that an interest-bearing asset’s value will change due to changing interest rates.
  7. Bonds & Fixed Income

    5 Fixed Income Plays After the Fed Rate Increase

    Learn about various ways that you can adjust a fixed income investment portfolio to mitigate the potential negative effect of rising interest rates.
  8. Mutual Funds & ETFs

    5 Best Mutual Funds in a Rising Rate Environment

    Find out which five mutual funds can provide the strongest portfolio hedges against the inevitable increase in long-term interest rates.
  9. Mutual Funds & ETFs

    The Top 5 Bond Mutual Funds for 2016

    Learn about bond mutual funds that investors may want to consider for 2016. Understand why the risk of rising interest rates is a concern heading into 2016.
  10. Investing

    7 Questions to Consider Before Investing in Bonds

    There is a significant number of questions every investor, private or institutional, should consider before investing in bonds.
RELATED FAQS
  1. What does floating stock tell traders about a particular stock?

    Learn about what floating stock tells a trader about a particular stock. One commonality of the biggest winners in stock ... Read Answer >>
  2. Why does float usually increase at the beginning of the week?

    Find out more about float and how checking float is created in the American banking system. Learn more about why the Federal ... Read Answer >>
  3. What months of the year typically have the highest float?

    Learn more about how float occurs within the United States and how it is monitored. Find out why float frequently happens ... Read Answer >>
  4. How does float affect the nation's money supply?

    Learn how float affects the appearance of the nation's money supply, and receive a brief lesson on how the U.S. government ... Read Answer >>
  5. What is the difference between holdover float and transportation float?

    Find out about float, which may become a thing of the past due to the steady decline of check writing and new services in ... Read Answer >>
  6. How do interest rates affect a bond's coupon rate?

    Find out how the changes in the national interest rate affect the coupon rates of newly issued bonds and why coupon rates ... Read Answer >>
Hot Definitions
  1. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  2. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  3. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  4. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  5. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  6. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
Trading Center