A Brief Note on Floating-Rate Bonds

The Reserve Bank of India (RBI) floating rate bonds offer an interest rate of 8.05%, which is paid bi-annually in January and July respectively.

So, what exactly are floating-rate bonds? A floating rate bond is a debt instrument that does not have a fixed interest rate. These bonds are also referred to as floaters or adjustable-rate bonds.

Typically, a floating rate bond is issued by the government, financial institutions, or corporations with two-five years of maturity. As per a floating bond rate, its interest payable time could be quarterly, bi-annually, or annually. For example, in the case of RBI floating bonds, the interest is paid bi-annually in January and July respectively.

The interest rate tends to fluctuate based on the benchmark the bond is drawn. For instance, in the case of RBI floating rate bond, the interest rate is linked to the rates of the National Savings Certificate (NSC). Such floating bonds offer interest of NSC along with 35 basis points (bps).

Generally, floating rate bonds are classified into two types: callable (redeemable) and non-callable.

A callable floating rate bond is one in which the issuer has the right to call back the floating rate bond before the maturity period after paying the bondholder the principal amount in full.

On the other hand, non-callable floating rate bonds do not provide the issuer with the facility to call them back or retire before the maturity period. The issuer is liable to pay the interest rate for such bonds, which is determined from the underlying benchmark, irrespective of the fact that they may be suffering losses.

Floating-rate bonds have relatively less exposure to market volatility and are safe investment options. These bonds also pose a certain level of risks such as interest rate risk, wherein there is no promise that the interest rate will rise in tandem with the rising market interest rate in a rising economy.

At the same time, in case an investor opts for a callable floating rate bond, there is a likelihood of the bond being called back by the issuer where while the investor gets the principal amount, they tend to lose on the interest payments in the future.