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Which of the following best defines a floating-rate bond?

  • a)
    A bond with a fixed interest rate and has better yield than varying interest rate bond

  • b)
    A bond with a varying interest rate and has lower yield than fixed interest rate bond

  • c)
    Bond with a varying interest rate and has better yield than fixed interest rate bond

  • d)
    A bond with a fixed interest rate and has lower yield than varying interest rate bond

Correct answer is option 'B'. Can you explain this answer?
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Which of the following best defines a floating-rate bond?a)A bond with...
Floating rate bonds have variable interest rate and protect investors against a rise in interest rates (which have an inverse relationship with bond prices). They also carry lower yields than fixed notes of the same maturity
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Which of the following best defines a floating-rate bond?a)A bond with...
Definition of a Floating-Rate Bond

A floating-rate bond is a type of bond that has a varying interest rate. Unlike fixed-rate bonds, the interest rate on a floating-rate bond is not fixed for the entire term of the bond. Instead, the interest rate is periodically adjusted based on a benchmark index, such as the London Interbank Offered Rate (LIBOR) or the US Treasury bill rate.

Distinguishing Characteristics of a Floating-Rate Bond

1. Varying Interest Rate: One of the main characteristics of a floating-rate bond is its varying interest rate. This means that the interest payments made to bondholders are not fixed but instead fluctuate based on changes in the benchmark index.

2. Lower Yield: Another characteristic of a floating-rate bond is that it typically offers a lower yield compared to fixed-rate bonds. This is because investors are compensated for the uncertainty associated with the varying interest rate. The lower yield reflects the risk that the interest payments may decrease if the benchmark index declines.

3. Interest Rate Adjustments: The interest rate on a floating-rate bond is adjusted periodically, usually every three to six months. The adjustments are based on the performance of the benchmark index. If the index increases, the interest rate on the bond will also increase, resulting in higher interest payments to bondholders. Conversely, if the index decreases, the interest rate and payments will decrease as well.

4. Protection Against Rising Interest Rates: Floating-rate bonds offer protection against rising interest rates. As the benchmark index increases, the interest rate on the bond adjusts accordingly, ensuring that bondholders receive higher interest payments. This feature makes floating-rate bonds attractive to investors who are concerned about interest rate risk.

5. Inflation Hedge: Since the interest rate on a floating-rate bond is tied to a benchmark index, which often reflects prevailing interest rates, these bonds can serve as a hedge against inflation. As inflation rises, interest rates tend to increase, leading to higher interest payments on floating-rate bonds.

In conclusion, a floating-rate bond is a type of bond that has a varying interest rate. It offers a lower yield compared to fixed-rate bonds but provides protection against rising interest rates and can serve as an inflation hedge. Therefore, option 'B' is the correct answer as it accurately defines a floating-rate bond.
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Which of the following best defines a floating-rate bond?a)A bond with...
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Which of the following best defines a floating-rate bond?a)A bond with a fixed interest rate and has better yield than varying interest rate bondb)A bond with a varying interest rate and has lower yield than fixed interest rate bondc)Bond with a varying interest rate and has better yield than fixed interest rate bondd)A bond with a fixed interest rate and has lower yield than varying interest rate bondCorrect answer is option 'B'. Can you explain this answer?
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