Floating Rate Note Research Articles

Flight to safety, intermediation frictions, and US Treasury floating rate note prices

While US Treasury floating rate notes (FRNs) are typically traded at a premium, they often experience significant price discounts. We find that this significant discount in US Treasury FRNs can be partly attributed to intermediation friction. The results reveal that new intermediation friction and canonical fight-to-safety channels can better explain the price changes in US Treasury FRNs.

Demystifying the US Treasury floating rate note puzzle: A swap market perspective

We compare two versions of the US Treasury floating rate note (FRN) price measured in Treasury auctions and in the swap market. Utilizing a proprietary dataset from J.P. Morgan, we find that the actual US Treasury FRNs are traded in premium in comparison with their synthetic equivalents in the swap market, and the premium amounts to four basis points on average. Moreover, they are priced up by four more basis points when the aggregate fixed income market is in turmoil, confirming that US Treasury FRNs are indeed safe assets, and thus require a price premium ex ante.

The US Treasury floating rate note puzzle: Is there a premium for mark-to-market stability?

We find that Treasury floating rate notes (FRNs) trade at a significant premium relative to the prices of Treasury bills and notes. This premium is directly related to the near-constant nature of FRN prices and is correlated with measures reflecting investor demand for safe assets. Money market funds are often the primary investors in FRNs, and the FRN premium is related to flows into funds with fixed net asset values, but not to flows into funds with variable net asset values. These results provide strong evidence that the FRN premium represents a convenience yield for the mark-to-market stability feature of FRNs.

A Valuation Model for the Variable Rate Demand Obligation (VRDO)

In this paper, a valuation framework is developed for the variable rate demand obligation (VRDO). The VRDO is a class of floating rate note whose coupon rate changes on a regular basis and is 'puttable' by the bondholder, given notice to the issuer. We model the coupon rate as a geometric Brownian motion process and assume that the incidence of puts is Poisson distributed, across time. Put events are assumed to be brought about by factors such as a change in the liquidity and consumption preferences of investors or a change in a Municipal issuer's creditworthiness.

A Valuation Model for the Variable Rate Demand Obligation

In this paper, a valuation framework is developed for the variable rate demand obligation (VRDO). The VRDO is a class of floating rate note whose coupon rate changes on a regular basis and is “puttable” by the bondholder, given a notice of one week to the issuer. We model the coupon rate as a geometric Brownian motion process and assume that the incidence of puts is Poisson distributed, across time. Put events are assumed to be brought about by factors such as a change in the liquidity and consumption preferences of investors or a change in a Municipal issuer’s creditworthiness. This paper is unique because as of July 2019 there exists no attempt at valuing VRDOs in the research literature.

An Empirical Analysis of Pricing in the Japanese Bond Markets

Both in the theoretical and applied literature of finance the difference in yield-to-maturity between corporate bonds and government bonds has been used as a measure of the risk of the former over the latter. While this approach has sometimes provided interesting results, the usefulness of yield spreads is lessened by ignoring the term structure of interest rate. This paper presents an alternative measure, “Asset swap spread”, use asset swaps to convert fixed income cash flows to floaters which refer LIBOR plus spread as index coupon rate. This spreads show much broader characteristics as well as riskiness of each corporate and government bonds. Effectively by using the swap curve to create a set of equal and opposite fixed-rate cash flows, we create a synthetic floating rate note (FRN) with an index coupon rate. Moreover, this value is now being captured through the trading of bond asset swap packages. Based on these ideas, we provide an introduction to government and corporate bond asset swaps, explaining their basic mechanics, the use of asset swap spreads in identifying and capturing relative value is discussed and the market drivers of asset swaps spreads are examined.

Common Liquidity Risk and Market Collapse: Lessons from the Market for Perps

We show how a high degree of commonality in investor liquidity shocks can diminish incentives for intermediaries to keep markets open and lead to market collapse, even without information asymmetry or news affecting fundamentals. We motivate our model using the perpetual floating rate note market where two years of explosive growth - in which issues by high quality borrowers were placed with institutional investors and traded in a liquid secondary market - were followed by a precipitous collapse when market intermediaries withdrew due to large order imbalances. We shed new light on the trade-off between ownership concentration and market liquidity.

Common liquidity shocks and market collapse: Lessons from the market for perps

We show how a high degree of commonality in investor liquidity shocks can diminish incentives for intermediaries to keep markets open and lead to market collapse, even without information asymmetry or news affecting fundamentals. We motivate our model using the perpetual floating-rate note market where two years of explosive growth – in which issues by high quality borrowers were placed with institutional investors and traded in a liquid secondary market – were followed by a precipitous collapse when market intermediaries withdrew due to large order imbalances. We shed new light on the trade-off between ownership concentration and market liquidity.

Interest Rate Digital Options and Range Notes

A European interest rate digital call (put) option pays one dollar at maturity if the prespecified reference interest rate is above (below) the strike level, and zero otherwise. A European range digital option pays one dollar if the prespecified reference interest rate lies within a specified range at maturity, and zero otherwise. A range note is a form of floating-rate note. The payment at the end of each period is defined to equal the number of days the reference interest rate lies within a specified range times an interest rate specified at the start of each period. Taking the initial term structure to be exogenous, closed-form solutions are derived for European interest rate digital options, digital range options, and range notes.

Swaps: Plain and Fanciful

ABSTRACTThe outstanding face amount of plain vanilla interest rate swaps exceeds two trillion dollars. While pricing and hedging of such swaps appear to be quite simple, many existing theories are based on the incorrect characterization of a swap as a simple exchange of a fixed for a floating rate note. This characterization is not consistent with standarized swap contracts and the treatment of swaps in bankruptcy. This paper provides an alternative perspective on swaps.

Floating Rate Notes and Immunization

As shown in several of those papers, the appropriate immunizing duration is a function of the assumption regarding the stochastic process describing the man? ner in which the term structure of interest rates changes. The theory has been well developed for ordinary bonds. This paper extends the existing literature on duration and immunization to a different type of security, the floating rate note. The floating rate note (FRN) is a debt security in which coupon payments adjust according to changes in interest rates. The coupons are closely tied to cur? rent short-term spot rates, with the result that prices of FRNs are always at or near par value. They became popular in this country in 1974 with a Citieorp issue