What are Floating Rate Notes?
Floating rate notes are debt securities that pay interest payments. The maturity date is fixed, however the interest rate is variable. The interest rate is tied to a benchmark, such as the BBSW. In practice, the variable rate is a fixed margin above the BBSW.
Since the BBSW (or most benchmarks for that matter) constantly change based on interest rate expectations, it follows that the interest payments received from an FRN also constantly change.
Investors usually purchase FRNs if they believe the interest rate is going to increase to ‘insure’ themselves from interest rate risk. The downside is that for this extra ‘insurance’ FRNs carry lower yields than fixed-rate instruments of the same term, credibility, etc.
Below is a visual example of the variable payments. Suppose the FRN duration is for 3 years, with revisions to the interest rate very year, and with face value $1m.