Important features floating rate notes, Financial Management

Reference Index

Every FRN chooses its own reference index upon which the calculation of each successive new coupon is based. The most commonly used reference index is LIBOR. It is a European market rate, used when European banks negotiate loan agreements. The British Banks Association which has a consortium of 24 British banks publishes it. Other reference indices are US 90-day Treasury Bill rates, Prime rates, Commercial Paper rates, etc. In India, MIBOR (Mumbai Inter-bank Offer Rate), 10-year Government Bond rate, 3-year Fixed Deposit rate of State Bank of India, etc., are some of the reference indices.

Quoted Margin to Reference Rate

This is also called default risk premium. This indicates the additional rate paid over and above the reference rate. It is the compensation for the credit risk of the issuer. The spread over the indexed rate could be fixed or varying. This spread depends mainly on the security offered by the issuer and his creditworthiness. Companies which claim good reputation in the market like Reliance and Tata would be able to issue FRNs with very thin premium.

Reset Frequency

Normally periodicity of coupon payments and the reset dates go together. That is, they are identical. However, on some FRNs, the coupon resets faster than it pays. For example, the coupon rate might be reset monthly but the coupon interest might be paid quarterly. In such cases, the interest payable on the bond will be revised three times between two consecutive interest payments if the reference rate undergoes change in all the three months.

Observation Date

The rules for determining the dates upon which the value of the reference index is observed for the purpose of setting the next coupon change from one issue to the other. The rule for specifying the observation date generally includes not only a specific time, but also a specific place. To quote an example, the observation date for three month LIBOR might be specified as the average offered rate for three month Eurodollar deposits at a list of reference banks in London at 12 Noon on the second business day preceding the reset date.

Maturity Date

This is simply the due date of the bond on which the principal of the bond and the last coupon payment become payable.


Posted Date: 9/10/2012 8:24:18 AM | Location : United States

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