Floating rate note

As floaters ( floating rate note, FRN ) is defined as a loan with a variable interest rate that is coupled every 3 /6 months to Libor or Euribor to a reference rate such as. In some cases an additional credit spread / allowance in the form is a coupon and / or address spreads added. Other variable-rate securities, however, are not floaters, but structured products.

• 4.1 convexity

Interest rate fixation

The interest rate is usually the reference value plus a contractually fixed premium (spread or quoted margin ), which reflects the credit quality of the issuer. Common reference rates are the 3 - or 6- month Euribor. In general, the interest rate for the next coupon in the payment of the previous coupon is fixed.

In each fixing date of the reference interest rate is fixed, but not the credit spread. Only if the credit spread in the fixing date corresponds to the credit risk, listed the bonds at face value.

Species

• Normal Floater: Here, the interest rate rises when interest rates rise, ie, the investor benefits from rising interest rates. Money market Floater: The interest rate is tied to a money market interest rate
• Capital market floaters: The interest rate is tied to a market interest rates

Assessment

Since a floater after a coupon payment at a market interest rate quoted at a time immediately ( if necessary with a credit deduction ), and thus a "fair " identifies interest rate, he must at this time a par, that is, to its nominal value, write. Accordingly, the exchange rate risk that the value of the floater due to a change in interest only for the period between two coupon dates.

Therefore, the yield is calculated until the next due date as a measure of floaters. It results from the nominal value plus the next coupon divided by the dirty price today minus one divided by the duration until the next coupon date.

The duration of a floater is the period until the next coupon, even if the term of the bond is many times longer.

Risks

Interest rate risk

For the issuer, there is the risk that interest rates rise and the interest payments will be higher than planned. However, the Issuer may hedge against this risk through interest rate swaps ( in the role of fixed payers ).

Credit risk

The credit risk is reflected in the bid.

Return to rollover

Since the effective interest rate is inaccurate due to the estimates of the performance of the variable interest rate, the return was used until the next due date as the measure. In this case, the credit risk is initially neglected. This relationship is called Return to rollover.

Solving for the return until the next due date this gives:

Surcharge

Quoted margin

A floater is characterized in that it guarantees a credit spread ( quoted margin ) over a reference rate. The quoted margin is the risk premium on the underlying reference index (usually 3 - or 6 month money market rates ).

Simple effective margin

The simple effective margin represents the actual course correction implicitly included in the price; they do occur if the coupon payment date, the price is not equal to one hundred.

The difference between the redemption price and the present course is spread over the term.

• SM: quoted margin
• Sem: simple effective margin
• Second factor is a correction to the base effect of the quoted margin: square meters ( 100 = / = qm/K_0

In each fixing date of the reference interest rate is fixed, but not the credit spread. Only if the credit spread in the fixing date corresponds to the credit risk, listed the bonds at face value. If the spread is lower than the one that was set for a FRN with the same credit rating of the issuer, the FRN listed below nominal. If the spread is higher the opposite is true.

Compound effective margin

Pari- listing in the fixing date

Using a no-arbitrage argument can be shown that a floater in the fixing date always quoted at par. A floating rate note can be synthetically generated by a rolling ( revolving ) investment in a Fixed Rate Note. These must have the same price.

Duration of a floater

The Macaulay duration is before repricing date 0 and after repricing date first

According to the definition of (), the modified duration before adjustment date must be 0 after reset date is the same.

The Euro - Duration is also equal to zero prior to interest rate adjustment date ( follows from definition) and on the interest rate adjustment date.

Convexity

The convexity is before repricing date 0 and after repricing date 2 analogous to one-year zero-coupon bonds.

Importance

With a floater one has to have the possibility to transfer a credit risk to pass without an interest rate risk. This is for example the asset-backed securities (asset -backed security) used to be where you expect the risk of the underlying receivables (asset) sold, the rather complex term structure, however, should remain hidden from the investors.

In Germany, inflation has remained low since the war and the interest rates relatively constant. Therefore, the coupons from the outset also be set for long -term bonds, as it keeps the interest rate risk generally manageable. In countries with high inflation rates are traditionally accustomed to short-term interest rates coupled coupons, however, are more common.

Categorization

Despite the variable interest rate on the floater belongs to the genus of fixed income securities. This follows from the definition of the word used here, " fixed interest rate ", after a successful independent rate of return is. This is given here, since the interest rate of the floater is adjusted relative to a reference interest rate.