In the United States, banks and financial service companies have been among the largest issuers of these securities.
A deleveraged floater, which gives the investor decreased exposure to the underlying index, can be replicated by buying a pure FRN and entering into a swap to pay floating and receive fixed, on a notional amount of less than the face value of the FRN.
Those issued by the U.S. Treasury, which entered the market in 2014, are traditionally regarded as having minimal credit risk.
[7] Opinion is divided as to the efficacy of floating-rate notes in protecting the investor from interest rate risk.
"[8] Commenting on the complexity of these securities, Richard S. Wilson of the credit rating firm Fitch Investors Services noted: "Financial engineers worked overtime on floating-rate securities and have created debt instruments with a variety of terms and features different from those of conventional fixed-coupon bonds....The major investment firms with their worldwide trading capabilities participate in these markets 24 hours a day.
[10] Suppose a new 5 year FRN pays a coupon of 3 months SOFR +0.20%, and is issued at par (100.00).
If the perception of the credit-worthiness of the issuer goes down, investors will demand a higher interest rate, say SOFR +0.25%.
This can be calculated as par, minus the difference between the coupon and the price that was agreed (0.05%), multiplied by the maturity (5 year).
That is the case because it is impossible to forecast the stream of coupon payments with accuracy, since they are tied to a benchmark that is constantly subject to change.
The effective spread is the average margin over the benchmark rate that is expected to be earned over the life of the security.
For notes that sell at a discount or premium, finance scholar Dr. Frank Fabozzi outlines a present value approach: project the future coupon cash flows assuming that the benchmark rate does not change and find the discount rate that makes the present value of the future cash flows equal to the market price of the note.
This approach takes into account the premium or discount to par value and the time value of money, but suffers from the simplifying assumption that holds the benchmark rate at a single value for the life of the note.
[11] A simpler approach begins with computing the sum of the quoted spread of the FRN and the capital gain (or loss) an investor will earn if the note is held to maturity:[citation needed]