What are floating rate bonds
Floating rate bonds, as the name suggests, have interest rates that change depending on the benchmark rate. It works on the basis of carry variable coupon rate which means that the interest rate is reset from time to time according to the market. Simply put, the interest rate on a floating rate bond keeps on changing throughout its tenure. In India, the rate on floating rate bonds depends on the repo or reverse repo rate.
Understand floating rate bonds
You can compare it with floating home loan rates for a better understanding on floating rate bonds. Like a floating home loan, you have to pay a higher EMI and interest rate depending on the increase in the repo rate. Quite the opposite happens with floating bonds as well. Any change in coupon rates can result in profit or loss for an investor. Usually, interest on such bonds is paid quarterly, half-yearly or annually as per the terms of the bond.
How do floating rate bonds work?
For ordinary bonds, whenever interest rates are raised, the bond price tends to fall and bond yields tend to be higher. But in the case of floating rate bonds, which are variable coupons whose rates are linked to the market rate. Therefore, whenever the interest rate rises, only its coupon rate increases without any improvement in the price of the bond, thereby providing better returns to investors. Similarly, when interest rate trends are down, coupon rates also fall, resulting in lower returns to investors. Hence, investors can consider investing in these floating rate bonds.