Floating-Rate Bond

A floating-rate bond is the opposite of a fixed-coupon bond. Instead of collecting the same coupon for the bond’s life, your interest rate resets every quarter or semi-annual, tracking a short-term benchmark like SOFR plus a spread. When interest rates rise, your coupon rises with them. You sacrifice yield for interest-rate stability and protection against rising rates—key for investors managing duration risk or expecting rates to move.

How floating-rate coupons work

A floating-rate bond specifies:

• A benchmark rate: SOFR (Secured Overnight Financing Rate), historically LIBOR, or sometimes a Treasury rate
• A spread: a fixed margin added to the benchmark, say, 200 basis points
• A reset frequency: quarterly, semi-annual, or annual

Each reset date, the coupon is recalculated: new coupon = current benchmark + 200 bps. As the benchmark rises, your coupon rises. As the benchmark falls, your coupon falls.

For example, a floating-rate bond might start with 3-month SOFR at 5.00% plus 200 bps spread = 7.00% coupon. Three months later, SOFR is 5.25%, so the coupon resets to 7.25%. Six months after that, SOFR has fallen to 4.50%, and the coupon is 6.50%.

Why issue or buy floating-rate bonds

Issuers. A company expecting to profit if rates fall issues floating-rate bonds to avoid being locked into high coupons. If rates do fall, the company’s coupon payments decline, improving cash flow. Banks and financial institutions particularly favor floating-rate debt because their assets are often floating-rate (loans, lines of credit), so the liability-asset match reduces interest-rate risk.

Investors. In a rising-rate environment, floating-rate bonds protect you. Your coupon rises as rates rise, offsetting the price decline that would hit a fixed-rate bond. In a falling-rate environment, floating-rate bonds underperform because your coupon falls. Investors buy floaters to hedge against rate increases or when they expect rates to rise.

Duration and price sensitivity

A floating-rate bond has very short duration—often less than 1 year. This is because the coupon adjusts to match market rates, so the bond’s price stays close to par. A fixed-rate bond loses value when rates rise; a floater’s coupon rises to compensate, and price stays flat.

This makes floating-rate bonds ideal for investors who want to reduce interest-rate risk. They sacrifice yield (floaters pay lower spreads than fixed-rate bonds) for price stability.

Spread and credit risk

The spread component (e.g., +200 bps over SOFR) is fixed and reflects the credit quality of the issuer. A high-quality issuer might issue at SOFR + 100 bps. A junk-rated issuer might need SOFR + 400 bps. The spread doesn’t change with market rates; only the benchmark does.

If the issuer’s credit rating deteriorates, the spread widens in the secondary market. A bond originally issued at SOFR + 200 bps might trade at SOFR + 400 bps after a downgrade. The coupon resets to the benchmark + original spread (not the new widened spread), but if you sell, you take a loss reflecting the spread widening.

Floaters and rising-rate environments

Floating-rate bonds are particularly attractive when rates are expected to rise. In 2022–2023, central banks raised rates sharply. Many investors rotated from fixed-rate bonds into floaters, seeking to benefit from coupon increases. As the Fed raised rates from near-zero to 5.5%, floater investors saw their coupons rise quarter-over-quarter, providing inflation-beating returns.

Floor and cap provisions

Some floating-rate bonds have a “floor”—a minimum coupon even if the benchmark falls below a threshold. For example, “SOFR + 200 bps, with a floor of 3%.” If SOFR is 2% (SOFR + 200 bps = 4%), the coupon is 4%. But if SOFR is 0.5%, you’d normally get 2.5%; instead, the floor kicks in and you receive 3%. Floors protect issuers in very-low-rate environments.

Conversely, some bonds have a “cap”—a maximum coupon even if the benchmark rises. A cap makes floaters less attractive to investors but cheaper for issuers to issue.

Floating-rate bond indices and ETFs

There are indices and ETFs tracking floating-rate corporate bonds. These are popular with investors seeking a money-market-like alternative that carries credit risk but very short duration. In a rising-rate environment, floating-rate bond ETFs often outperform fixed-rate bond funds.

Extension risk in floaters

A risk of floating-rate bonds is extension risk. You buy a floating-rate bond expecting short duration and the ability to reinvest coupons at rising rates. But if the issuer’s credit deteriorates sharply, the bond might fall in value. If you then try to sell, you face a distressed market. The coupon might still be floating, but the bond’s value has collapsed due to credit risk, and you’re stuck.