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Using Floating Rate Notes to Control Risk and Return

categories: Investing (Investment Management), RMA, Fixed Income, Research Paper, MITROFF Andrea, general

Floating rate notes, or "floaters," are bonds whose coupon is tied to a prevailing interest rate, such as the six-month T-bill rate. Since their coupon is not fixed, they offer investors a  unique tool to control risk and return  In particular, floaters offer a long stream of cash flows with low duration (term structure risk exposure). Many, such as mortgage-backed floaters, offer a higher yield than a comparable short-term security while maintaining high quality. Finally, floaters allow an investor to take on active spread bets while taking on little or no term structure risk. To benefit from these attributes, an investor must understand the nature of floaters from their simple form (the default-free floater) to the more complex (floaters with a corporate spread).