Info 1: floating rate bonds definition
Info 2: how floating rate bonds work
Info 3: floating rate bonds vs fixed interest bond
Info 4: example of floating rate bonds
Opening information:
Floating rate bonds break into three words floating, rate, and bonds. floating means not fixed, rate means percentage, and bonds mean attached contract. floating rate bonds mean debt contracts that pay nonfixed percentage interest.
So now let’s have a look at what is floating rate bonds, how floating rate bonds work and involved in the public market, and what is the difference between floating rate bonds and fixed interest rate bonds, finally one brief example about floating rate bonds.
Info 1: floating rate bonds definition
Mr.Nathip is a businessman and stock Investor who is the CEO of the Steel Industry, where his main operation is to run his business successfully without losses.
However, whenever he had more dividends and income than average earnings, he normally didn’t prefer to save that money indeed Nathip invested in stock equities and bonds.
This means he had 80 percent of the portfolio in equities and 20 percent of the earnings on the debt instruments called bonds.
Moreover when compared to any other bond he normally invests in the bonds which pay the interest rate based on the up and fall of the interest rate on the mortgage rate.
When the mortgage rate rises, the bond instruments’ interest rate too increases, and when mortgage interest decreases the bond’s interest rate decreases too for his holding bonds during the period until it’s mature or expires.
Mr. Nathip realized it had huge benefits because when it rose to a normal bond interest rate, he got more money risk freely.
Here the bond that pays the interest rate using the third-party mortgage interest rate indeed of a fixed rate is known to be a floating rate bond. Let’s dive into how floating rate bonds work and are involved in the public market.
Info 2: how floating rate bonds work
Floating rate bonds don’t represent any of the specific things or objects, Instead, they are debt instruments that pay the interest rate by following other items’ fluctuation of interest rate.
The other item rate could be anything such as mortgage market interest rate, federal funds Interest rate, Any country central bank exchange rate or home loan interest rate, unemployment interest rate extra… It could be any kind of interest rate but with the following of other items continuously until such holding bonds expired.
Supposedly if the purchased or Holden bond wouldn’t follow the interest rate of any other external things and paid any lower or higher of any kind of fixed interest for the Investors they are not Considered as floating rate bonds.
However, the floating rate would be determined for the bond based on what interest rate of the item would be taken as a floating rate.
If the floating rate bond is issued with an Interest rate following an unemployment rate of 6 percent, that 6 percent is the floating rate for the floating rate bonds.
If the same unemployment rate increased to 8 percent, then such a floating rate bond had an 8 percent interest because it followed the unemployment interest rate as a fall and up rate.
On the other hand, if the same bond is issued and follows the interest rate of home loans, then such home loan interest rates rise and fall would become the floating rate for the floating bond interest rate.
So the floating rate is not fixed, despite it being issued based on any kind of followed interest, it fluctuates day by day and year and year.
Most people confuse the floating rate bond and fixed interest bond, so let’s jump into the key difference in it anyway.
Info 3: floating rate bond and fixed interest bond
The floating rate bonds’ main reference is to follow other interest rate product interest on the issued bond, so it’s uncontrollable and could rise and fall every year.
On the other side, fixed interest bonds are the one that shows the pre-determined marked interest rate with no changeable percent and don’t follow any other rate of interest by external securities.
To make you more clear about the floating rate bonds let’s look into one brief example below.
Info 4: example of floating rate bonds.
Say company H had issued the debt instruments of bonds which are worth 1000 dollars for each unit with a pre-determined interest rate of 8 percent.
The local government also issued 1500-dollar municipal bond units with an interest rate of 2.7 percent.
Here none of the two bonds came in the category of floating interest rate bonds, because their interest rates are fixed and do not follow any external item interest rate.