RBC Primer on Floating Rate Notes
RBC Global Asset Management published a piece entitled, "Floating Rate Notes: A Primer," which reviews the benefits of floating rate notes in a rising rate environment. RBC's piece states, "Floating rate notes can be beneficial in a rising rate environment due to their ability to protect principal and generate attractive income. This paper outlines key features of floaters and how they can support high quality bond portfolios given their stable market values and performance." The article also discusses how floaters work. RBC GAM explains, "Floating rate notes, commonly referred to as FRNs or 'floaters,' have a variable rate of interest that resets periodically. Floating rate notes are different from fixed rate bonds in that the coupon payment is made up of two components: (1) an underlying reference benchmark and (2) an additional margin." The brief says, "The reference benchmarks fluctuate and reset with the market, therefore driving the variability in the floater's coupon, while generally limiting the note's market value changes. Common reference benchmarks are Treasury Bills (T-Bills) and 1-month or 3-month LIBOR (London Interbank Offered Rate).... The additional margin, or spread, is added to the reference benchmark to determine the periodic payment the issuer is obligated to pay over the underlying benchmark." RBC adds, "Recall that fixed rate bond prices move in the opposite direction of interest rates. Therefore, during a rising rate environment, fixed rate bonds are susceptible to price erosion, whereas floaters are better protected because the coupon rate adjusts with the now higher market rate, returning the price to par at reset."
