Floating Rate Bonds (FRBs) are a type of debt instrument where the interest rate, or coupon, is not fixed but fluctuates periodically based on a benchmark rate such as the Repo Rate, LIBOR (London Interbank Offered Rate), or the Government Securities Yield. These bonds provide investors with variable returns that move in line with changes in prevailing interest rates, offering protection against rate volatility.

In simple terms, while a fixed-rate bond pays the same interest throughout its tenure, a floating rate bond adjusts its interest payout periodicallyósay, every six months or annuallyódepending on movements in the chosen reference rate. For instance, if the benchmark rate rises, the coupon payment also increases, and vice versa.

The formula for calculating the coupon on a Floating Rate Bond is:

Coupon Rate = Benchmark Rate + Spread

The ìspreadî is a fixed percentage determined at the time of issuance and remains constant during the bondís life, representing the additional yield above the benchmark.

Advantages: Floating rate bonds are preferred during periods of rising interest rates, as they offer better protection against inflation and interest rate risk. They are also attractive for investors seeking stable real returns with lower price volatility compared to fixed-rate bonds.

Risks: The primary risk associated with these instruments is reinvestment riskóif interest rates fall, the coupon payments reduce, leading to lower returns. Moreover, in uncertain rate environments, predicting income from such bonds can be challenging.

In India, entities such as the Reserve Bank of India (RBI) and corporate issuers issue floating rate bonds to balance investor demand and market liquidity. Overall, FRBs are valuable instruments for diversifying fixed-income portfolios, particularly when interest rates are expected to fluctuate.