floatingrate

Floating rate refers to an interest rate on a loan or security that changes over time, based on a reference index plus a fixed margin. On each reset date, the coupon or payment amount is recalculated using the current value of the reference rate plus the issuer’s specified spread. This mechanism makes the instrument’s interest payments responsive to changes in prevailing rates.

Common reference indices include secured overnight rates such as SOFR in the United States, SONIA in the United Kingdom, and EURIBOR in the euro area. Historically, LIBOR was widely used, but many markets have transitioned to risk-free or nearly risk-free benchmarks. The reset frequency can be monthly, quarterly, or at other intervals, and the resulting payments can rise or fall accordingly. Some floating-rate instruments also include caps, floors, or collars that limit how high or low payments can move.

Applications and implications: floating-rate instruments are widely used in corporate debt, bank loans, and adjustable-rate mortgages. They can reduce interest rate risk for borrowers when rates decline, but increase payment uncertainty if rates rise. For investors, floating-rate securities can offer protection against rising rates, but prices may be less sensitive to rate changes than fixed-rate bonds; liquidity and credit risk vary by issuer.

Risks include reference-rate reform and potential discontinuation, basis risk (the mismatch between the reference rate and actual financing costs), and credit risk linked to the issuer.