DEFINITION of 'Floater'

A floater is a bond or other type of debt whose coupon rate changes with market conditions (short-term interest rates).

A floater is also known as floating-rate debt.

BREAKING DOWN 'Floater'

A floater is a fixed income security that makes coupon payments that are tied to a reference rate. The coupon payments are adjusted following changes in the prevailing interest rates in the economy. When interest rates rise, the value of the coupons is increased to reflect the higher rate. Possible reference or benchmark rates include the London Interbank Offer Rate (LIBOR), Euro Interbank Offer Rate (EURIBOR), federal funds rate, US Treasury rates, etc. For example, a floater bond may have the coupon rate set at "3-month T-bill rate plus 0.5%." If the perception of the creditworthiness of the issuer turns negative, investors may demand a higher interest rate at, say 3-month T-bill rate plus 0.75%.

A floater lies in contrast to a fixed-rate note, which pays the same interest rate for its entire maturity. Because floaters are based on short-term interest rates, which are generally lower than long-term rates, a floater typically pays lower interest than a fixed-rate note of the same maturity.

A floater is more beneficial to the holder as interest rates are rising because it allows a bondholder to participate in the upward movement in rates since the coupon rate of the bond will be adjusted upwards. For this reason, floaters carry lower yields than fixed notes of the same maturity as investors may be willing to accept a lower initial rate in exchange for the possibility of a higher rate if market rates rise. Conversely, a floater is less advantageous to the holder when rates are decreasing because the rate at which they will receive interest declines.

A government or corporate issuer may pay coupons on a floater monthly, quarterly, semi-annually, or annually. The coupon payments are unpredictable, although the security may have a cap and a floor, which allows an investor to know the maximum and/or minimum interest rate the note might pay. A cap is the maximum interest rate that the note can pay, regardless of how high the benchmark rate climbs, and a floor is the lowest allowable payment. A floater’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.

One type of floater that may be issued is called the inverse floater. The coupon rate on an inverse floater varies inversely with the benchmark interest rate. The coupon rate is calculated by subtracting the reference interest rate from a constant on every coupon date. When the reference rate goes up, the coupon rate will go down since the rate is deducted from the coupon payment. A higher interest rate means more is deducted, thus, less is paid to the debtholder. Similarly, as interest rates fall, the coupon rate increases because less is taken off. To prevent a situation whereby the coupon rate on the inverse floater falls below zero, a restriction or floor is placed on the coupons after adjustment. Typically, the floor is set at zero.

RELATED TERMS
  1. Super Floater

    A super floater is a floating-rate CMO tranche with a leveraged ...
  2. Leveraged Floater

    A leveraged floater, also known as a leveraged floating-rate ...
  3. Coupon Rate

    Coupon rate is the yield paid by a fixed income security, which ...
  4. Current Coupon Bond

    A bond with a coupon rate that is within 0.5\% of the current ...
  5. Current Coupon

    A current coupon refers to a security that is trading closest ...
  6. Coupon

    A coupon is the annual interest rate paid on a bond, expressed ...
Related Articles
  1. Investing

    Comparing Yield To Maturity And The Coupon Rate

    Investors base investing decisions and strategies on yield to maturity more so than coupon rates.
  2. Investing

    Why Do Companies Print Coupons?

    Coupons save customers money, but there's also a lot in it for the company.
  3. Investing

    Another Idea for Rising Rates Protection

    Floating-rate notes can help investors fight rising interest rates.
  4. Personal Finance

    The Top 6 Online Coupons And How To Use Them

    Learn the basics of couponing so that you can get creative with your savings strategy and evolve beyond the basic coupon book.
  5. Investing

    Charles Schwab: Short-Term Investments a Way to Play Rising Rates

    Bond investors focused on the short term could benefit from rising interest rates, says Charles Schwab.
  6. Investing

    Float Over to Floating Rate ETFs

    Floating rate notes are another avenue for bond investors to consider when it comes to reducing interest rate risk.
  7. Investing

    Corporate Bonds: Advantages and Disadvantages

    Corporate bonds can provide compelling returns, even in low-yield environments. But they are not without risk.
RELATED FAQS
  1. What is the difference between yield to maturity and the coupon rate?

    A bond's coupon rate is the actual amount of interest income earned on the bond each year based on its face value. Read Answer >>
  2. What does it mean if a bond has a zero coupon rate?

    Find out what it means when a bond has a coupon rate of zero and how a bond's coupon rate and par value affect its selling ... Read Answer >>
  3. How can I calculate a bond's coupon rate in Excel?

    Find out how to use Microsoft Excel to calculate the coupon rate of a bond using its par value and the amount and frequency ... Read Answer >>
  4. If I buy a $1,000 bond with a coupon of 10% and a maturity in 10 years, will I receive ...

    See how fixed-income security investors can expect to use coupon rates on semi-annual payments if the bond or debt instrument ... Read Answer >>
  5. When Does a Corporation Decide to Refinance Debt?

    Favorable market conditions or the strengthening of a credit rating may lead to corporate refinancing. Read Answer >>
Trading Center