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Buoyed by Rates

Floating rate notes—or “floaters,” as they are widely called—are bonds with a coupon rate that “floats,” meaning they don’t have a fixed interest payment. Rather, the interest rate fluctuates based on the rate of a benchmark index or security. If the benchmark rises, so does the amount of interest paid by the floater (and the reverse if the benchmark falls).

When the U.S. Treasury launched its first batch of floaters in early 2014, economic conditions didn’t exactly highlight the appeal of such securities. Treasury floaters are initially issued with two-year maturities and offer interest payments that fluctuate based on the rates at the most recent 13-week Treasury bill auction. As a result, their performance has differed little from regular three-month Treasuries.

That might be changing now that the market generally expects a slow and steady rise in interest rates in the months ahead. Floating-rate notes could represent a convenient way to quickly capture changes in short-term interest rates.

“With a two-year floater, if rates rise an investor can benefit without having to roll over investments several times a year,” says Collin Martin, Director, Fixed Income, at the Schwab Center for Financial Research.

Corporations also issue floating rate bonds, which tend to offer higher yields than those issued by the Treasury, but Collin says such securities should be approached with a bit more caution.

“Corporate bonds are inherently more risky than those issued by governments,” he says. “Investment-grade floaters could be an attractive option, but investors should be cautious about lower-rated high-yield floaters. If rates rise, a financially stressed company might find it difficult to service its floating debt.”

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Important Disclosures

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower-rated securities are subject to greater credit risk, default risk and liquidity risk.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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