Floating Rate Bonds Risks and Benefits
Floating rate bonds offer a number of benefits and these bonds are extremely popular with investors right now because interest rates are low. These bonds also carry a number of risks as well though, and these risks are often ignored by investors or overlooked. Do the benefits outweigh the risks when it comes to these securities? The answer may be different for each investor and you will need to compare the risks and benefits in your own specific situation to determine this. Unlike typical municipal bond interest rates or the rates with other fixed rate securities a floating rate bond has a rate that fluctuates and is reset at specific intervals. This factor can benefit investors but is also considered risky depending on the direction the interest rates are headed.
The benefits of floating rate bonds include the fact that these investments can help protect you against increases in the interest rate, because the rate you receive on the bond will reset to the higher rate plus the agreed upon percentage. Most of these bonds reset the rate paid every six months, but some do this quarterly or annually instead. The yield for these bonds is another benefit, because it is generally higher than the yield offered by corporate bond rates and much higher than munis offer. This high yield can often cause an investor to overlook the risks that are included with these bonds though, and a risk versus benefit analysis should be performed for each bond considered.
There are a number of risks associated with floating rate bonds that may outweigh the benefits in some cases. The price of this type of bond poses a big risk to investors, because of interest rates drop then so will the rates paid on the bond. There is also a risk of default which is linked to the credit rating of the bond issuer. If the treasury bonds rates are currently 1% but these rates were 4% then the investor loses out when the interest rate on the bond is reset and lowered. If the current rate is 4% but the bond rate was initially 1% the investor will benefit when the rate is reset. The floating rate can be a risk and a possible benefit at the same time.
Floating rate bonds may be the perfect choice for some investors but these bonds may be all wrong for others. Every investor has set strategies, acceptable risk levels, and investment goals, and these bonds may or may not fit into the picture. The risks may be too high for some while considered acceptable for others. Some investors search for high yield options while others look for conservative choices that provide maximum protection. For some investors the
zero coupon bond rates may offer similar yields while incurring less risk. Since every investor is different you will need to look at the risks and benefits in relation to your specific investment guidelines, style, and goals to see if bonds with floating rates are right in your situation or not.