Question

Discuss what is the duration of all floating rate debt instruments.

Answer 1

Floating rate note is a bond with coupons that is benchmarked to a benchmark interest rate. Benchmark rate could be US treasury rated, LIBOR, municipal or mortgage interest rate indexes.

The coupon payments can be calculated using the below formula:

Coupon=Reference index rate + fixed spread

The reference index rate is a short-term interest rate like LIBOR. The fixed spread does not change over the life of the bond. It is determined at the time of issuance and is based on the issuer’s credit risk.

It is a short-term bond that is rolled over at every reset date. They have maturity dates from 18 months to five years. Floating rate note can be used to manage risk and return when interest rates are rising. They also hold their value during inflation.

Almost all floating rate instruments have quarterly payments. It pays higher yields if interest rates increase and lower yields if interest rats fall. It can be used to reduce the volatility in an investor’s portfolio. It carries less credit risk compared to fixed rate bonds.

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