Floating Rate Bonds

Floating rate bonds, also known as floaters or variable rate bonds, are fixed income instruments whose coupon (interest) rates get changed at periodic intervals. These bonds are issued by both companies and governments. Coupon rates of floating rate bonds are linked to pre-set benchmark rates like repo rate, MCLR (Marginal Cost of Funds Based Lending Rate), T-Bill yields, NSC (National Savings Certificate) rates, etc. Therefore, the income from floating rate bonds may vary with the changes in their linked benchmark dates.

Floating rate bonds in India usually make interest payments at regular intervals and repay the face value amount on its maturity date. However, the interest payments offered by these bonds may increase or decrease as per the movements in their linked benchmark rates. The changes in their linked benchmark rates are transmitted to their coupon rates on pre-set dates. The re-setting of floater coupon rates at periodical intervals leads them to be aligned more or less with the prevailing market rates. This reduces the interest rate risk for the investors during a rising interest rate regime.

Variable Coupon Rate : The coupon rate of a floating rate bond usually consists of two components - a base rate and a spread over it. The base rate is linked to the benchmark rate whereas the spread is fixed at the time of bond issuance or discovered through an auction process undertaken at the time of bond issuance. For example, the coupon rate of RBI's Floating Rate Savings Bond is linked to the interest rate offered on National Savings Certificate with a spread of 35 basis points (0.35%) over the prevalent NSC interest rate. Similarly, the coupon rate of a GOI FRB 2028 (i.e. floating rate bond issued by the central government having a maturity date of October 4, 2028) consists of a floating base rate and a spread of 64 bps (i.e. 0.64%) over the base rate fixed for the entire bond tenure. The variable base rate of this bond is reset after every six months and is equal to the average of the Weighted Average Yield (WAY) of the last three auctions of 182 Day T-Bills held before the rate resetting date.

Coupon Rate Reset Frequency : The interest rates of floating rate bonds can be reset at monthly, quarterly, half yearly, annually or other pre-decided intervals. In case of floating rate bonds issued by the Government of India, the reset frequency has been set at half yearly intervals. The only exception is GOI FRB 2035, whose coupon rate is reset after five years. This bond was issued on January 25, 2005 with a maturity date of January 25, 2035.

Interest Payments Dates : The interest payable of a floating rate bond is calculated on its face value depending on the rate set for the coupon period. Then, the interest component is paid to the bond investors on their pre-determined coupon payment dates.

Also Check: Corporate Bonds in India

Types of Corporate Floating Rate Bonds : These bonds are issued by both private and public sector companies. The coupon rates of these bonds are linked to benchmarks such as MCLR, Nifty 10 year Benchmark G-Sec Index, Nifty 10 year Benchmark G-Sec (Clean Price) Index, etc. These floating rate bonds can be issued in the combinations of secured/unsecured, listed/unlisted, rated/unrated, non-convertible/optionally convertible, etc.

Types of Government Floating Rate Bonds GOI Floating Rate Bonds (GOI FRBs) : These bonds are issued by the Government of India and are listed on stock exchanges. The interest component is paid to the investors at half yearly intervals. Similarly, the coupon rates of these bonds are also reset at half yearly intervals, just before the commencement of the semi-annual coupon period. Here is a list of GOI FRBs currently available for investments.

Central Government Floating Rate Bonds Current Coupon Rate (p.a.) Interest Rate Reset Frequency Maturity Date  : GOI FRB 2028 7.11% 6 months October 4, 2028 GOI FRB 2031 6.63% 6 months December 7, 2031 GOI FRB 2033 7.81% 6 months September 22, 2033 GOI FRB 2034 6.99% 6 months October 30, 2034 GOI FRB 2035 6.66% 5 years January 25, 2035.

Floating Rate Savings Bond (FRSB) 2020 (Taxable): While FRSBs are also issued by the Government of India, these are not transferable and hence, cannot be traded on stock exchanges. Here is a list of the other features of FRSB that investors should know:

• Minimum investment: Rs 1,000 (in multiple of Rs 1,000 thereafter)
• Maximum investment: No Limit
• Coupon (Interest) rate: 8.05% p.a. (Linked to prevailing NSC interest rates plus a fixed spread of 35 bps) for the period from July 1, 2025 to December 31, 2025
• Tenure: 7 years
• Frequency of interest payment: Semi-annual
• Date of interest payments: January 1 and July 1 of each year.
• Lock-in period: 7 years (lower for senior citizens depending on their age)
• Premature withdrawal facility: FRSBs do not allow premature withdrawal facility except to its senior citizen investors. Senior citizens aged 60-70 years can make premature withdrawals after the completion of 6 years. Those aged between 70-80 years & above 80 years can make premature withdrawals after the completion of 5 years and 4 years respectively.
• Premature withdrawal penalty: 50% of last coupon payment.
• Collateral: FRSBs cannot be pledged to avail loans

Eligibility Criteria Required for investing in FRSB (i) resident individuals of India in his/her individual capacity, or in individual capacity on joint basis, or in individual capacity on any one or survivor basis, or on behalf of a minor as father/mother/legal guardian; (ii) a Hindu Undivided Family

Also Check: Tax Free Bonds in India

Rajkot (Gujarat) Solar Energy Pvt. Ltd. issued a floating rate corporate bond on 30th January 2017. It was issued with a benchmark rate of the prevailing MCLR rate. Therefore, the interest payments made to investors till its maturity date will fluctuate in line with the changes in the MCLR rate.

Both corporates and governments issue floating rate bonds. Hence, the channels to buy these bonds could differ. Ways to buy floating rate bonds in India issued by companies

• Primary auctions: Investors can buy floating rate bonds issued by companies through private placement and public issues.
• Secondary market: Another way investors can purchase floating rate bonds issued by companies is through conventional stock brokers, OBPP (Online Bond Platform Providers) and partner financial marketplaces like Paisabazaar.

Ways to buy floating rate bonds issued by government

• Primary auctions: A government issues and sells new floating rate bonds through auctions, which are conducted by the RBI. Investors can directly buy & invest in floating rate bonds from the issuer through these channels:
  • RBI Retail Direct: An online platform wherein retail investors can participate in the primary auctions of government bonds.
  • Banks: Investors can also invest directly in floating rate bonds by opening gilt accounts with banks. They can use their existing demat accounts for holding their floating rate bonds.
  • Authorised primary dealers: Investors can also approach RBI-authorised primary dealers to submit their bids in the primary markets.

• Secondary Market: Different ways to invest in floating rate bonds through secondary market, includes:
  • RBI Retail Direct: Investors can also use the RBI Retail Direct platform to invest in floating rate bonds through the secondary market.
  • Stock exchanges: Investors can use NSE goBID (Government Bond Investment Destination) and BSE Direct web platforms for buying/selling floating rate bonds in the secondary market.
  • OBPP: Retail investors can also consider OBPP, another convenient and increasingly popular option, to invest in floating rate bonds through secondary markets.

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1. Benefit from rising interest rates The coupon rates of non-floating rate bonds remain fixed despite the changes in interest rates and inflation rates during a rising interest rate regime, leading to opportunity loss and lower inflation-adjusted income for their investors. Floating rate bonds allow investors to hedge against these risks as their coupon rates remain more or less adjusted with the changes in the market interest rates.

2. Lower volatility in bond prices Bonds having fixed coupon rates have an inverse relationship with the interest rate regimes. The prices of fixed rate bonds tend to increase when interest rates fall and vice versa. In case of floating rate bonds, the interest rates are aligned with the market rates and thus, have lower volatility in prices than other types of bonds of similar maturities. This makes floating rate bonds ideal for investors preferring stable bond prices.

3. Can be purchased and sold in the secondary market While GOI FRBs are tradable in the stock exchanges, FRSB 2020 have lock-in periods and thus, are not listed in the exchanges. Thus, investors seeking to purchase or sell GOI FRBs can do so through the stock exchanges as per their market prices, which can be more or less than their face value.

1. Lower coupon rates Floating rate bonds carry lower interest rate risk than their fixed counterparts of similar maturity and credit profiles. This leads issuers to offer lower coupon rates on their floating rate bonds than their fixed rate bonds.

2. Higher income uncertainty Floating rate bonds offer lower income certainty to their investors due to their floating interest rates. This makes floating rate bonds unsuitable for investors requiring a predictable income.

3. Lower interest income during falling rate cycle While investors of floating rate bonds benefit from rising interest rate regimes, the opposite would be true in case of falling interest regimes. During an easing rate cycle, investors of fixed rate bonds would continue to earn the same interest rates while the investors of floating rate bonds would witness a reduction in their coupon rates.

4. Lower scope of capital appreciation during easing rate cycles The inverse relationship of bonds with market interest rates leads fixed rate bond prices to appreciate during an easing interest rate cycle. As the coupon rates of floating rate bonds factor in the interest rate cycles, these bonds offer very low potential of capital appreciation during easing rate cycles. This feature makes floating rate bonds less attractive for investors aiming at capital gains from fixed income instruments during a falling interest rate regime.

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Investors should factor in their expectations regarding interest income, interest rate regime and capital appreciation while choosing between fixed rate and floating rate bonds. Investors seeking market-aligned interest income and/or lower volatility in bond prices can consider floating rate bonds. Investors seeking higher income stability and/or higher scope of capital appreciation during falling interest rate regimes should avoid floating interest bonds. They should instead prefer fixed rate bonds.

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Here's a quick comparison between floating rate bonds and fixed rate bonds. Particulars Floating Rate Bond Fixed Rate Bond Coupon structure Benchmark rate + Spread Fixed Coupon (interest) payments May change as per changes in their linked benchmark rates (Repo rate, MCLR, T-bill yields, etc.) Remains unchanged till the bond's maturity date Income predictability Low as interest payments may change over time High as the interest payments remain unchanged till the bond’s maturity date Interest rate risk Lower risk as the coupon rate adjusts as per the changing interest rate cycles Higher than the floating rate bonds as the interest rate remains fixed irrespective of the changing rate cycles When to invest During rising interest rate regime During stable or falling interest rate regime Who should invest Investors who are comfortable with changing interest income and seek interest income that is aligned with market interest rate movements Conservative investors looking for predictable and stable income streams regardless of market conditions.

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Both the interest income and capital gains from floating rate bonds are taxable. The interest income is taxed as per the investor's slab rate. The taxation on capital gains, however, depends on how long you have held these bonds. Floating rate bonds held for less than a year are considered as short-term capital gains and are taxed as per the tax slab rate of the investor. Floating rate bonds held for more than a year are taxed at 12.5% (without indexation) under long-term capital gains.