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The Money Markets Handbook: A Practitioner's Guide by Moorad Choudhry

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CHAPTER 3

Floating-rate notes

Strictly speaking floating-rate notes or FRNs are bonds and therefore part of the bond markets. However, because of the nature of their construction, particularly with regard to the way their coupons are re-set at regular (such as quarterly) intervals, they trade in some respects similarly to money market instruments. They are also used for liquidity purposes by bank Treasury desks. Hence we include some detail on FRNs here in this chapter.

Floating-rate note conventions

Securities known as floating rate notes (FRNs) are bonds that do not pay a fixed coupon but instead pay coupon that changes in line with another specified reference interest rate. The FRN market in countries such as the US and UK is large and well-developed; floating-rate bonds are particularly popular with short-term investors and financial institutions such as banks. With the exception of its coupon arrangement, an FRN is similar to a conventional bond. Maturity lengths for FRNs range from two years to over 30 years. The coupon on a floating-rate bond “floats” in line with market interest rates. According to the payment frequency, which is usually quarterly or semi-annually, the coupon is re-fixed in line with a money market index such as the London Inter-bank Offer Rate or LIBOR. Often an FRN will pay a spread over LIBOR, and this spread is fixed through the life of the bond. For example a sterling FRN issued by the Nationwide Building Society in the UK maturing in August 2006 ...

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