Floater

As floaters or FRN (English floating rate note , abbreviated FRN ) refers to a bond with a variable interest rate , which usually at a reference rate as the Libor or Euribor is coupled. To price the issuer's creditworthiness, a surcharge on the reference interest rate is agreed. Variable-interest securities with a different design are not viewed as floaters, but as structured products.

Interest rate fixing

Interest is usually paid at the reference value plus a contractually fixed premium ( spread or quoted margin ) that reflects the creditworthiness of the issuer . Frequent reference interest rates are the 3 or 6 month EURIBOR . As a rule, the interest rate for the next coupon is set when the previous coupon is paid.

The reference interest rate is set anew at each fixing date, but not the credit rating spread. The bond is only quoted at face value if the credit rating spread on the fixing date corresponds to the credit risk.

species

Normal floaters : Here the interest rate increases when the interest rate level rises, ie the investor benefits from rising interest rates.

Money market floater : The interest rate is linked to a money market interest rate
Capital market floater : the interest rate is linked to a capital market interest rate

Mixed floaters are bonds with initially a fixed interest rate, then after a certain period of time a variable interest rate or vice versa.

Cap floaters contain a maximum interest rate. They are floating rate bonds with a maximum interest rate . The interest rate remains limited to this fixed maximum rate if the sum of the reference interest rate and the spread exceeds this amount .

Floor floaters contain a minimum interest rate. They are floating rate bonds with a minimum interest rate . If the reference interest rate plus a spread falls below this minimum rate, the investor is entitled to interest payments in the amount of the minimum rate.

Minimax floaters (also called collar ) are a combination of cap and floor floaters. They are floating rate bonds with a minimum and maximum interest rate. If the reference interest rate plus a spread falls below or exceeds this minimum or maximum rate, the investor is entitled to interest payments in the amount of the minimum rate or the interest remains limited to this maximum rate.

Reverse floaters are bonds with a fixed term for which the variable interest rate is the difference between an arbitrarily set (high) interest rate and a reference interest rate (e.g. LIBOR ). This contains a cap so that the buyer does not have to pay the issuer if the reference interest rate rises too high. For example, 10% less 3-month EURIBOR can be set as interest with a cap of 10%. As a result, the investor benefits from falling interest rates.

Flip-flop floaters give the issuer the right to convert a long-term debt security into a short-term one.

Mismatch floaters are floaters in which the interest rate adjustment date and the change in the reference interest rate coincide with each other.

rating

Since a floater is quoted at a market interest rate (possibly with a credit discount) at a point in time immediately after a coupon payment and thus shows a "fair" interest rate, it must be quoted at this point in time , i.e. at its nominal value . Accordingly, there is a price risk that the value of the floater will change due to a change in interest rates, only for the period between two interest rates.

The return until the next due date is therefore calculated as the key figure for 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 a risk that interest rates will rise and the interest payments will be higher than planned. However, the issuer can hedge against this risk through an interest rate swap (in the role of the fixed payer ).

Credit risk

The credit risk is reflected in the surcharge.

Return to rollover

Since the effective interest rate is imprecise due to the estimates of the development of the variable interest rate, the return until the next due date is used as the key figure. The credit risk is neglected for the time being. This connection is called return to rollover.

${\ displaystyle (K_ {0} + c_ {0}) (1 + y ^ {*} \ cdot \ tau ^ {+}) = 100 + c ^ {+}}$

Broken down according to the return until the next due date , this results in: ${\ displaystyle y ^ {*}}$

${\ displaystyle y ^ {*} = \ left ({\ frac {100 + c ^ {+}} {K_ {0} + c_ {0}}} - 1 \ right) \ cdot {\ frac {1} { \ tau ^ {+}}}}$

Surcharge

Quoted margin

A floater is characterized by the fact that it guarantees a credit rating spread (“quoted margin”) using a reference interest 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 price correction implicitly contained in the price. It occurs when the price is not equal to one hundred on the coupon date.

The difference between the repayment rate and today's rate is distributed over the term.

${\ displaystyle sem = (qm + {\ frac {RZK-K_ {0}} {T}}) \ cdot {\ frac {100} {K_ {0}}}}$

sqm: quoted margin
sem: simple effective margin
The second factor is a correction of the base effect of the quoted margin: qm (100) = / = qm / K_0

The reference interest rate is set anew on each fixing date, but not the credit rating spread. The bond is only quoted at face value if the credit rating spread on the fixing date corresponds to the credit risk. If the spread is lower than that set for an FRN with the same credit rating as the issuer, the FRN is quoted below the nominal value. If the spread is higher, the opposite is true.

Compound effective margin

Parity quotation on the fixing date

A no-arbitrage argument can be used to show that a floater is always quoted at par on the fixing date. A floating rate note can be generated synthetically through a rolling (revolving) investment in a fixed rate note. These must then have the same price.

Warning !: This only applies in the event that the credit spread corresponds to the credit risk (sem = qm).

Duration of a floater

The Macaulay duration is 0 before the rate adjustment date and 1 after the rate adjustment date.

According to the definition of ( ), the modified duration before the adjustment date must also be 0; after the adjustment date it is the same . ${\ displaystyle D_ {M}}$ ${\ displaystyle D_ {M} = D_ {m} (1 + y)}$ ${\ displaystyle 1 / (1 + y) / 100}$

The euro duration is also zero before the interest rate adjustment date (follows from the definition) and after the interest rate adjustment date . ${\ displaystyle {\ frac {100 + E_ {t} + qm} {1 + {\ frac {E_ {t}} {100}}}}}$

convexity

The convexity is before the interest rate adjustment date 0 and after the interest adjustment date 2, analogous to one-year zero bonds.

${\ displaystyle {CON} _ {Euro} (y) = PV '' (y) ~}$

${\ displaystyle {KON} _ {m} = {\ frac {PV '' (y)} {PV (y)}} = {\ frac {{KON} _ {Euro} (y)} {PV (y) }}}$

${\ displaystyle {KON} _ {M} = {KON} _ {m} (y) (1 + y) ^ {2} ~}$

meaning

With a floater, you have the option of transferring a credit risk without having to pass on an interest rate risk. This will, for example, the asset-backed securities ( asset-backed security exploited), will be sold in which, although the risk of the underlying receivables, but the rather complex maturity structure is to remain hidden from the investor.

In Germany , inflation has remained low since the war and interest rates have remained relatively constant. For this reason, the coupons are also set in advance for long-term bonds, since the interest rate risk is generally considered to be manageable. In countries that are traditionally used to high inflation rates, coupons linked to short-term interest rates are more common.

Categorization

Despite the variable interest rate, the floater belongs to the class of fixed-income securities. This results from the definition of the word “fixed interest”, which is used here, according to which there is an entitlement to interest that is independent of success. This is the case here because the floater's interest rate is adjusted to a reference interest rate.

Individual evidence

^ Günther Wöhe: Introduction to general business administration , 22nd edition, Munich, Verlag Vahlen, 2005, p. 700.