Floating Rate Bond
A Floating Rate Bond (FRB) is a debt instrument whose coupon resets periodically based on a reference benchmark rate, protecting investors from rising interest rates by ensuring the coupon moves in line with market yields.
The Government of India has periodically issued FRBs as part of its dated securities programme. Unlike fixed-rate G-Secs where the coupon is locked at issuance, the coupon on a GoI FRB is linked to the weighted average yield of the 91-day Treasury Bill, derived from the past six months of T-Bill auctions and announced by the RBI at each reset date. A fixed spread of a few basis points is added over this reference rate.
The primary appeal of FRBs is interest rate risk mitigation. In a rising rate environment, fixed-rate bond prices fall because future cash flows are being discounted at higher rates. FRBs, however, reset their coupons upward, so their prices remain closer to par. Conversely, in falling rate environments, FRBs underperform fixed-rate bonds because their coupons decline with the reference rate.
The RBI Retail Direct platform, launched in November 2021, made GoI FRBs directly accessible to retail investors alongside T-Bills and G-Secs. This was part of a broader effort to deepen the domestic government bond market and reduce over-reliance on institutional holders (banks, insurance companies) who hold these securities primarily for SLR compliance.
In the corporate bond market, FRBs linked to the Mumbai Interbank Offer Rate (MIBOR) or the 91-day T-Bill have been issued by banks and large NBFCs. The reset mechanism in corporate FRBs may differ from government FRBs — some use quarterly resets, others semi-annual — and the spread over the reference rate reflects credit risk.
Duration of an FRB is much shorter than its tenor because the coupon resets bring cash flows effectively closer in time from a risk perspective. This makes FRBs suitable for investors with a short investment horizon who want to participate in the bond market without taking significant duration risk. Mutual funds with a mandate to reduce duration — such as floater funds — primarily hold FRBs and short-maturity instruments linked to overnight or short-term reference rates.