Floating Rate Notes Research Articles

The pricing of U.S. Treasury floating rate notes

Since January 2014, the U.S. Treasury has been issuing floating rate notes (FRNs). These notes pay quarterly interest based on an average of the constant maturity rates of newly issued three-month T-bills during the quarter. We show how to price such FRNs. We estimate that they have been paying excess interest between 3 and 42 basis points above the implied interest of other Treasury securities. We interpret this fact through the lens of a model where money-like assets differ in their degrees of moneyness. Additional empirical evidence supports this interpretation.

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.

Floating Rate Notes in High Rate Environment and the Stock Market Response

Previous study finds that the firms with inferior growth options tend to issue callable bonds. Typically, these firms are characterized by stock underperformance. Previous study also finds that the floating rate as a superior alternative to the call provision, which is restrictive, when the interest rates are likely to fall. We study the long-term stock performance of floating rate notes (FRNs) issuing firms, issued when the interest rates are high. Stock overperformance would suggest floating rate as a preferred choice by the firms with high growth options rather the call option. We find that the FRNs are generally investment grade with extremely rare presence of a call option. We perform the analysis using Buy and hold abnormal return (BHAR) as the proxy for the long-term stock overperformance/underperformance. A sample of floating rate notes issued (1654) from 1992 to 2007, a period of high interest rates, reveals significant overperformance by the floating rate notes issuing firms in the high-rate paradigm. High growth firms, in the high-rate environment, significantly benefit from the floating rate provision which is less restrictive and less costly than the call option, which typically provides call protection period and pays a call premium. Floating rate provision better mitigates the interest rate risk for the firms in the high-rate environment. We find that the smaller, high growth, higher leverage, less profitable firms with greater agency issues benefit more from issuing FRNs in the high-rate environment. Our study has relevance to the stock portfolio construction and performance. We also perform a comparative analysis using the sample of floating rate notes issued (270) during 2008 to 2018, a period of low interest rates, and find stock underperformance. The implications are that the call option likely is a better choice for the firm since the firm preserves the right to forego exercising the option.

How floating rate notes stopped floating: Evidence from the negative interest rate regime

We analyse the impact of stakeholder interactions with the market as a consequence of the negative interest rate regime on the pricing of selected Floating Rate Notes (FRNs). The range of reactivity of financial markets and issuers to uncertainty caused by an untested boilerplate term in bond contracts are thoroughly outlined. The subject clause stipulates ‘not applicable’ as the minimum rate of interest, raising confusion regarding payment obligations between issuers and investors. We highlight the range of challenges by drawing parallels with the pari passu saga, noting a comparatively faster qualitative response to legal uncertainty across the FRN industry. We support these findings empirically, by observing that markets do –to varying degrees– price stakeholder activities with possible impact on the legal certainty of FRNs, like court decisions, industry association statements, and public positions of sovereigns. In turn, issuers are willing to react to legal risks quickly, if costs of inertia are low. This is reflected also in the relevant changes in the FRN issuance structure in the past few years. The announcement of further lower for longer rates in the Euro Area provides evidence that the FRN market appreciates the current protection of negative coupons even under a lower Euribor. Consequently, this appears to confirm a situation where Floating Rate Notes turned de facto into Floored Rate Notes, in part because of legal uncertainty in the N/A clause.

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.

Should the U.S. Government Issue Floating Rate Notes?

Since January 2014 the U.S. Treasury has been issuing floating rate notes (FRNs). We estimate that the U.S. FRNs have been paying excess interest between 5 and 39 basis points above the implied cost for other Treasury securities. We find a strong positive relation between our estimated excess spreads on FRNs and the subsequent realized excess returns of FRNs over related T-bill investment strategies. With more than 300 billion dollars of FRNs outstanding, the yearly excess borrowing costs are estimated to be several hundreds of millions of dollars. To rationalize this finding, we examine the role of FRNs from the perspective of optimal government debt management to smooth taxes. In the model, bills can be cheaper to issue than FRNs, and the payoffs for FRNs are perfectly correlated with future short rates. FRNs can be used to manage the refinancing risk from rolling over short-term debt. We derive conditions under which the issuance of FRNs can optimally be positive.

Shaking the Capital Markets Tree: Euro Area Capital Market Sensitivity to Stakeholder Activities During the Negative Interest Rate Regime

This contribution analyses the impact of stakeholder interactions with the market as a consequence of the negative interest rate regime on the pricing of selected Floating-rate notes (FRNs), to understand the range of reactivity of financial markets and issuers to uncertainty caused by an untested boilerplate term in bond contracts. The subject clause stipulates ‘not applicable’ as the minimum rate of interest, which raises confusion regarding payment obligations between issuers and investor. Subsequently, we hypothesize that markets would be noticeably more sensitive to stakeholder activities, adapting to reduce risks. Using event studies, we find that markets do, to varying degrees, price stakeholder activities like court decisions, industry association statements, and public positions of sovereigns. In turn, issuers are willing to react to legal risks quickly, if costs of inertia are low. This is reflected also in the significant changes in the FRN issuance structure in the past few years.

Shaking the Capital Markets Tree: Euro Area Capital Market Sensitivity to Stakeholder Activities during the Negative Interest Rate Regime

We analyse the impact of stakeholder interactions with the market as a consequence of the negative interest rate regime on the pricing of selected Floating-rate notes (FRNs). The range of reactivity of financial markets and issuers to uncertainty caused by an untested boilerplate term in bond contracts are thoroughly outlined. The subject clause stipulates ‘not applicable’ as the minimum rate of interest, which raises confusion regarding payment obligations between issuers and investors. This is discussed from a legal perspective. Empirically, we find that markets do---to varying degrees---price stakeholder activities like court decisions, industry association statements, and public positions of sovereigns. In turn, issuers are willing to react to legal risks quickly, if costs of inertia are low. This is reflected also in the significant changes in the FRN issuance structure in the past few years. The announcement of further lower for longer rates in the Euro Area provides evidence that the FRN market appreciates the current protection of negative coupons even under a lower Euribor.

The New Market for Treasury Floating Rate Notes

Treasury Floating Rate Notes (FRNs) were introduced in 2014 as a way to diversify the U.S. Treasury funding base and lower its borrowing costs. Using daily data on all Floating Rate Notes issued from 1/2014 to 10/2016 we find that FRNs deliver a statistically significant excess return relative to the underlying index, as well as relative to other short-term interest rate benchmarks. However, yield spreads with respect to comparable maturity fixed rate Treasuries, quarterly data on auction outcomes, and block holding disclosures by financial institutions support the objectives set forth by the Treasury. Collectively our article provides a perspective on FRN contract features, the return and risk of these instruments, and insight into their clientele.

The Last Three Days of January 2014: Treasury Notes, Gold Certificates and the Federal Reserve

The last three days of January 2014 all have material relevance to the rise of forward guidance as the premier policy tool of the Federal Reserve. On January 29, the US Treasury will introduce Floating Rate Notes, the first new bond exactly 17 years since the introduction of TIPS. January 30 marks the 80th anniversary of the Gold Reserve Act, legislation that passed the reigns of US monetary policy to the Treasury until the Fed-Treasury Accord of 1951 while January 31 marks the last day in office of Ben Bernanke. All three of the events mark important guideposts for forward guidance and the Federal Reserve's ability to credibly commit to lower rates for longer.

Candidate Market Models and the Calibrated CIR++ Stochastic Intensity Model for Credit Default Swap Options and Callable Floaters

We consider the standard Credit Default Swap (CDS) payoff and some alternative approximated versions, stemming from different conventions on the premium and protection legs. We consider standard running CDS (RCDS), upfront CDS and postponed-payments running CDS (PRCDS). Each different definition implies a different definition of forward CDS rate, which we consider with some detail. We introduce defaultable floating rate notes (FRN)'s. We point out which kind of CDS payoff produces a forward CDS rate that is equal to the fair spread in the considered defaultable FRN. An approximated equivalence between CDS's and defaultable FRN's is established, which allows to view CDS options as structurally similar to the optional component in defaultable callable notes. We briefly investigate the possibility to express forward CDS rates in terms of some basic rates and discuss a possible analogy with the LIBOR and swap default free models. Finally, we discuss the change of numeraire approach for deriving a Black-like formula for CDS options or, equivalently, defaultable callable FRN's. We also introduce an analytical formula for CDS option prices under the CDS-calibrated SSRD stochastic-intensity model, and discuss the impact of the different CIR++ dynamics parameters on the related CDS options implied volatilities. Hints on possible methods for smile modeling of CDS options are given for possible future developments of the CDS option market.

A Generalized Approach to Price and Duration of Non-Par Floating-Rate Notes

A Generalized Approach to Price and Duration of Non-Par Floating-Rate Notes

The Pricing of Bull and Bear Floating Rate Notes: An Application of Financial Engineering

M Financial engineering can be described as the construction of a security or a portfolio of securities with an otherwise unavailable risk-return configuration. A classic example of financial engineering is the recent issuance of floating rate notes (FRNs) with nontraditional coupon reset formulas. A traditional FRN resets the coupon rate periodically at some fixed margin over (or under) a reference index rate, for example, LIBOR + 0.25%. Since 1986, a number of FRNs have been issued with reset formulas at some fixed rate minus the reference rate. These can be called bull or inverse floaters or, as named by some issuers, yield curve notessee Ogden [8] for further institutional details. The idea is that an investor who is bullish on bond prices would be attracted to a security that has a coupon rate that moves inversely to the market rate. SallieMae (the Student Loan Marketing Association) has issued several bull floaters, including the initial one that had a reset formula of 17.20% LIBOR. Albert Lord, the chief financial officer of SallieMae, said at the time (April 1986):

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