Floating Rate Note
A floating rate note (FRN) is a debt security whose interest payments reset periodically based on a reference benchmark rate, such as the Secured Overnight Financing Rate (SOFR), causing coupon income to move with prevailing short-term interest rates rather than remaining fixed for the life of the bond.
Floating rate notes differ from fixed-rate bonds in one fundamental respect: the coupon is not locked in at issuance. Instead, the coupon resets at defined intervals — typically every 30, 90, or 180 days — by adding a fixed spread to a reference benchmark rate. The U.S. Treasury began issuing its own FRNs in 2014, with 2-year maturities and coupons tied to the 13-week Treasury bill rate. Corporate and financial institution issuers have long used FRNs, historically referencing LIBOR and more recently SOFR following the LIBOR transition mandated by U.S. and international regulators.
The principal appeal of FRNs in a rising-rate environment is that their coupons automatically increase as benchmark rates climb, which limits the price depreciation that fixed-rate bond holders experience when market yields rise. This characteristic makes FRNs shorter in effective duration than comparably maturing fixed-rate bonds, and investors use FRNs to reduce interest rate risk within fixed income portfolios.
Corporate FRNs are prevalent in the investment-grade and leveraged loan markets. In the leveraged finance space, broadly syndicated loans — large credits extended to below-investment-grade borrowers — almost universally carry floating rates tied to SOFR plus a spread determined at issuance. These instruments form the raw material pooled inside collateralized loan obligations (CLOs), discussed elsewhere in this glossary.
U.S. Treasury FRNs trade actively in the secondary market and are widely held by money market managers, bank treasury departments, and institutional fixed income accounts seeking short-duration government exposure. Their yields closely track the federal funds rate target set by the Federal Reserve, making them sensitive barometers of monetary policy expectations.
Investors comparing FRNs to TIPS should note that FRNs are not inflation-indexed: their reset rates track a benchmark rate, which may or may not keep pace with inflation depending on whether the Federal Reserve is tightening in response to inflationary pressures. A period of elevated inflation combined with low benchmark rates — sometimes called financial repression — can result in FRN holders earning negative real returns despite periodic coupon resets.