When it comes to investing, bonds can be a great option for those who are looking for a more stable and reliable investment. One type of bond that investors may consider is a floating rate bond. These bonds offer several unique features that can make them a valuable addition to any investment portfolio. In this post, we’ll explore what floating rate bonds are, how they can be traded, and the benefits and drawbacks of investing in them.
What are Floating Rate Bonds?
A floating rate bond, also known as a variable rate bond, is a type of bond that has a variable interest rate. Unlike fixed rate bonds, where the interest rate remains the same throughout the life of the bond, the interest rate on a floating rate bond is adjusted periodically based on a benchmark interest rate such as the London Interbank Offered Rate (LIBOR) or the prime rate. This means that as interest rates rise or fall, the interest payments on the bond will also rise or fall.
How are Floating Rate Bonds Traded?
Floating rate bonds can be bought and sold through a variety of investment vehicles such as mutual funds, exchange-traded funds (ETFs), and individual bonds. The value of a floating rate bond will fluctuate based on changes in interest rates, just like any other bond. When interest rates rise, the value of the bond will decrease, and vice versa.
Benefits of Investing in Floating Rate Bonds:
One of the main benefits of investing in floating rate bonds is their ability to provide protection against rising interest rates. As interest rates increase, the interest payments on the bond will also increase, providing investors with a higher return on their investment. This can be especially valuable during times of inflation when interest rates tend to rise.
Another benefit of investing in floating rate bonds is their relatively low risk compared to other types of bonds. Because the interest rate on a floating rate bond is adjusted periodically, the risk of default is reduced, as the issuer of the bond can adjust the interest rate to reflect changes in their financial situation.
Drawbacks of Investing in Floating Rate Bonds:
While floating rate bonds can be a valuable addition to an investment portfolio, they do come with some drawbacks. One of the main drawbacks is their potential for lower returns compared to other types of bonds. Because floating rate bonds have a variable interest rate, their returns may not be as high as fixed rate bonds when interest rates are low.
Another potential drawback of investing in floating rate bonds is their liquidity. Because they are not as widely traded as other types of bonds, it may be more difficult to buy and sell them, particularly during times of market volatility.
Floating rate bonds can be a valuable addition to any investment portfolio, offering protection against rising interest rates and relatively low risk. However, investors should be aware of their potential for lower returns and liquidity issues. Before investing in floating rate bonds, it’s important to carefully consider your investment goals and risk tolerance.
Investopedia. (2022). Floating Rate Bond. Retrieved from https://www.investopedia.com/terms/f/floatingratebond.asp
Fidelity. (2022). Floating Rate Bonds: A Bond Investor’s Guide. Retrieved from https://www.fidelity.com/learning-center/investment-products/fixed-income-bonds/floating-rate-bonds-guide