Floating-Rate Note - FRN

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DEFINITION of 'Floating-Rate Note - FRN'

A debt instrument with a variable interest rate. Also known as a “floater” or “FRN," a floating rate note’s interest rate is tied to a benchmark such as the U.S. Treasury bill rate, LIBOR, the fed funds or the prime rate. Floaters are mainly issued by financial institutions and governments, and they typically have a two- to five-year term to maturity.

BREAKING DOWN 'Floating-Rate Note - FRN'

Floating rate notes (FRNs) make up a significant component of the U.S. investment-grade bond market, and they tend to become more popular when interest rates are expected to increase. Compared to fixed-rate debt instruments, floaters protect investors against a rise in interest rates. Because interest rates have an inverse relationship with bond prices, a fixed-rate note’s market price will drop if interest rates increase. FRNs, however, carry lower yields than fixed notes of the same maturity. They also have unpredictable coupon payments, though if the note has a cap and/or a floor, the investor will know the maximum and/or minimum interest rate the note might pay.

An FRN's interest rate can change as often or as frequently as the issuer chooses, from once a day to once a year. The “reset period” tells the investor how often the rate adjusts. The issuer may pay interest monthly, quarterly, semiannually or annually. FRNs may be issued with or without a call option.

One major FRN issuer is Fannie Mae. Its FRNs have different reference rates, including three-month T-bills, the prime rate, the fed funds rate, one-month LIBOR and three-month LIBOR. Commercial banks, state and local governments, corporations and money market funds purchase these notes, which offer a variety of terms to maturity and may be callable or non-callable.

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