Floating-Rate Bonds: How Variable-Rate Debt Protects Against Rising Rates

How Floating-Rate Bonds Work

A floating-rate bond's coupon is calculated as: Reference Rate + Fixed Spread. For example, a floater might pay SOFR + 2%. If SOFR is 5.3%, the coupon is 7.3%. At the next reset date, if SOFR is 5.5%, the coupon adjusts to 7.5%. The reference rate reflects the general level of short-term interest rates, while the fixed spread compensates for the issuer's credit risk. The coupon resets at predetermined intervals — typically every 1, 3, or 6 months. Because the coupon adjusts to current market rates, the bond's price stays close to par (100) at each reset date. Between resets, the price may fluctuate slightly if market rates move, but the movement is small because the next reset will adjust the coupon. Floating-rate bonds issued by the US government (Treasury FRNs) reset weekly based on the 13-week Treasury bill auction rate and are considered the safest floaters available. Compare floating-rate notes with Treasury bills →

Zero Duration: Why Floaters Don't Fall When Rates Rise

The key feature of floating-rate bonds is near-zero interest rate duration. Duration measures a bond's sensitivity to interest rate changes. A fixed-rate bond with a 5-year maturity has a duration of approximately 4.5 to 5 years — a 1% rate rise causes a 4.5% to 5% price decline. A floating-rate bond with quarterly resets has a duration equal to the time until the next reset — approximately 0.25 years. This means a 1% rate rise causes only a 0.25% price decline, which is quickly recovered at the next reset when the coupon adjusts higher. This near-zero duration makes floaters one of the best hedges against rising interest rates. However, floaters still carry credit risk — if the issuer defaults, the bond loses value regardless of its floating coupon. Floaters also carry spread risk: if the issuer's credit quality deteriorates, the fixed spread may no longer compensate for the risk, and the bond's price will fall. Learn how duration affects all bond types →

Floating-Rate ETFs and Funds

The most popular floating-rate ETFs include USFR (WisdomTree Floating Rate Treasury Fund, 0.15% expense ratio), FLOT (iShares Floating Rate Bond ETF, 0.15%), and FLTR (VanEck IG Floating Rate ETF, 0.14%). USFR holds Treasury floating-rate notes, making it the safest option with zero credit risk. FLOT and FLTR hold investment-grade corporate floaters, offering higher yields with modest credit risk. For high-yield exposure, there are floating-rate bank loan funds that invest in senior secured loans with floating coupons — these offer the highest yields but carry significant credit risk. Floating-rate ETFs provide instant diversification across hundreds of floaters with low minimum investments. They are suitable for investors who want to reduce interest rate risk in their bond portfolios but maintain exposure to credit markets. Choose between bond ETFs and mutual funds →

When Floaters Outperform Fixed-Rate Bonds

Floating-rate bonds outperform fixed-rate bonds in three environments. First, during rising rate environments: as central banks raise rates, floater coupons increase, producing positive returns while fixed-rate bonds decline. Second, during high inflation: central banks raise rates to combat inflation, and floater coupons rise with them, preserving purchasing power. Third, during flat or inverted yield curves: when short-term rates are similar to or higher than long-term rates, floaters offer competitive yields without taking on long-term interest rate risk. Conversely, floaters underperform fixed-rate bonds during falling rate environments. In 2020, when rates dropped to zero, floaters yielded less than 1% while fixed-rate bonds rallied significantly. Understanding the interest rate cycle is essential for timing the allocation between floating and fixed-rate bonds. How inverted yield curves affect bonds →

What is a floating-rate bond?

A floating-rate bond is a bond with a variable coupon that resets periodically based on a reference rate (like SOFR) plus a fixed spread. The coupon adjusts to current market rates at each reset date, keeping the bond's price stable near par. Floating-rate bonds have near-zero interest rate duration, meaning their prices barely change when market rates move. They are issued by governments, financial institutions, and corporations as a way to manage interest rate risk.

How do floating-rate bonds protect against rising rates?

Floating-rate bonds protect against rising rates because their coupons reset to current market rates at regular intervals. When rates rise, the coupon on a floater increases, offsetting the price decline that fixed-rate bonds experience. The near-zero duration of floaters means a 1% rate increase causes only a minimal (0.1% to 0.25%) price decline, compared to a 4% to 5% decline for a 5-year fixed-rate bond. In 2022, floating-rate notes returned positive returns while the broad bond market fell 13%. This rate protection makes floaters ideal for rising rate environments.

What are the risks of floating-rate bonds?

Floating-rate bonds carry three main risks. First, credit risk: like any bond, floaters can default. Corporate floaters are subject to the same credit analysis as fixed-rate bonds. Second, spread risk: if the issuer's credit quality deteriorates, the fixed spread may become inadequate, and the bond's price will fall. Third, reinvestment risk: when coupons reset lower, investors receive less income. During falling rate environments, floaters significantly underperform fixed-rate bonds. Additionally, floating-rate ETFs may have slightly higher expense ratios than comparable fixed-rate bond ETFs. Despite these risks, floaters are considered one of the safest bond types for capital preservation in uncertain rate environments.

What is the difference between SOFR and LIBOR?

SOFR (Secured Overnight Financing Rate) is the benchmark interest rate that replaced LIBOR (London Interbank Offered Rate) after the LIBOR manipulation scandal. SOFR is based on actual transactions in the Treasury repurchase agreement market, making it more transparent and harder to manipulate than LIBOR, which was based on bank submissions. SOFR is a secured rate (backed by Treasury collateral), while LIBOR was unsecured. SOFR has been the recommended replacement for USD LIBOR since 2022. Most new floating-rate bonds reference SOFR, while older bonds may still reference LIBOR until they mature or are amended. The transition from LIBOR to SOFR is one of the largest changes in financial market infrastructure in decades. Understand Treasury benchmarks →

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