What are Floating Rate Bonds?

Last Updated: 2 Sep 2025

Businesses can make effective products, provide quality services and ensure their customer experience is supreme. However, one thing that is usually missing when looking at a company’s success is their cash flow or how much capital they have to expand. Expansion is the fundamental factor for a company to ensure sustainability and increased profitability. If a company does not expand, it becomes stagnant when its competitors find new customers, new territories, and new opportunities to grow their business.

One more factor which is influenced by the expansion of a company is its stock price. If investors see no growth potential for a company shortly, they avoid buying its shares leading to the prices trading sideways.

For a company to expand, the most important thing is capital. Expansion requires opening a new factory, buying new equipment, hiring new employees, and investing in marketing or advertising. To ensure that the company has the needed capital, it can either borrow from the banks, raise capital through IPO, or issue bonds.

This blog details the last option where the company issues bonds to raise capital and cover the current or future expenses of the company.

What are Bonds?

bonds are debt instruments, which implies that they work on the principle of loans, where a company issues bonds to borrow money from the lender, also called the bondholder. The company promises the lender a regular predetermined interest on the principal amount. In bond terms, this interest rate is called a coupon. However, some bonds do not have a fixed coupon rate as it fluctuates based on several predetermined benchmarks. These types of bonds are known as floating rate bonds.

How do bond yields fall and rise?

Similar to most things in the secondary market, bond yields also depend on the supply and demand equilibrium. Bonds yield has an inverse relationship with bond prices. For example, if you have a bond with a 5-year maturity, a 5% coupon rate, and a face value of Rs 10,000. Each year the bond will pay you interest of Rs 500. Now, if the interest rates in the market rise above 5%, investors will not buy your bonds but buy the new ones that come with an interest rate higher than 5%

As a result, you will have to lower the price of your bond to increase its yield. When you lower the price, the coupon rate increases because of the lower face value, thus increasing the bond’s yield.

This is how bond yields fall and rise based on the prevailing interest rates in the market.

What are floating-rate bonds?

Bonds typically have a fixed interest rate or coupon. Suppose you purchase a bond of Rs 10,000 at a coupon rate of 5%. Then, you will receive an annual interest of Rs 500 from the issuer of the bond. This interest remains fixed and does not change in accordance with the prevailing interest rate in the market.

But what is a floating bond? It is a type of debt instrument that does not have any fixed coupon rate, but the rate of interest on it changes according to the benchmark against which the bond is issued. Benchmarks are economic instruments that determine the overall economy. For instance, repo rate or reverse repo rate can be used as the benchmark for a floating rate bond.

How do floating rate bonds work?

Over the last decade, a large part of Indian bonds has been floating-rate government borrowings. For instance, in 2020, the RBI issued a floating rate bond that pays semiannually. After six months, the interest rate is again reset by the RBI. The Interest Rate on the floating rate bond would be 35 points higher than the prevailing NSC (National Savings Certificate) rate.

The current interest rate for the National Savings Certificate is 6.8%. Hence, the interest rate for the RBI’s floating rate bond is 6.8% + .35% = 7.15%.

Generally, a floating rate bond is issued by the government, financial institutions, and corporations with a maturity of two to five years. Depending on the floating bond rate, its interest payable time may be quarterly, semi-annually, or annually.

What are the different classifications of a floating-rate bond?

A floating-rate bond is mainly classified into two types:

• Callable Floating Rate Bonds: It has a clause that enables the issuing entity to call back the bond prior to maturity. This term means that after repayment of the initial principal, the issuer ceases paying interest to the bondholder. They allow the issuer to hedge declining/rising rates and retire the bond prior to its stated maturity.
• Non-callable Floating Rate Bonds: These floating-rate bonds lack the provision for calling back the bond or retirement of the instrument before the date of maturity. For these types of bonds, the issuer is obligated to make the rate of interest at the underlying benchmark, even if the issuer would incur a loss after paying the interest.

Advantages and Disadvantages of Floating Rate Bonds

Like all debt instruments, they have both pros and cons.

Advantages:

• Less volatility: They adjust to market rates, reducing exposure to price volatility compared to fixed-rate bonds.
• Higher yields: Can earn higher returns when interest rates go up.
• Low-risk option: Government-discount floating rate bonds are safe as they are benchmarked against risk-free references like repo rates.
• Diversification: Suitable for stabilising a portfolio, especially when rates would most probably rise.

Disadvantages:

• Lower yield: Can yield less than fixed-rate bonds if short-term rates fall.
• Interest rate risk: Increases won’t keep pace with market rate increases.
• Default risk: Issuers might default on interest or principal.
• Call risk: Callable bonds can be repurchased early, eliminating future interest receipts.

Example of a Floating Rate Bond

A change in the interest payment on the floating rate bond is tied to a benchmark, such as the MIBOR (Mumbai Interbank Offer Rate). Take the example of a 3-year bond with an interest of MIBOR + 2%. If MIBOR is 5%, then the bond will pay 7% as its first interest. In the next period, if MIBOR increases to 6%, then the interest must be recalculated to 8%.
This makes the floating rate bonds relatively appealing in an environment where interest rates are on the rise because their yields are higher than those of the fixed rate bonds, but less so in interest-rate-declining environments.

Floating Rate Bonds vs. Fixed Rate Bonds

Point of Difference	Floating Rate Bonds	Fixed Rate Bonds
Interest rate	Changes from time to time based on a reference rate, such as the RBI repo rate.	Remains the same for the entire term of the bond.
Interest income	Can increase or decrease depending on market interest rates.	Stays the same, offering predictable income.
Risk	Higher risk due to fluctuating returns.	Lower risk as returns are fixed and known in advance.
Best suited for	Investors who expect interest rates to rise in the future.	Investors who prefer stability and fixed returns.
Return predictability	Uncertain, as rates may change during the bond’s life.	Highly predictable, as rates do not change.

How to Invest in Floating Rate Bonds in India

Investing in India’s floating-rate bonds is a simple and good interest rate change hedge. Here is how you do it:

1. Identify Issuers: Issuers of floating rate bonds in India include the Government of India, public sector undertakings, and private enterprises. Government bonds, such as the RBI’s floating rate savings bonds, are sought after since they are safe.
2. Select a Platform: You can invest using banks, the RBI Retail Direct platform, or stockbrokers for listed corporate bonds. Make sure the platform is registered and trustworthy.
3. Know Terms: Check the benchmark rate, spread, and reset frequency. For instance, a bond pegged to the MIBOR with quarterly resets implies interest rates resetting every three months.
4. Place Your Order: Open a demat account if necessary, and place the order accordingly based on the face value of the bond.
5. Monitor Regularly: Monitor interest rate fluctuations and performance of the bond to keep it in sync with your investment objectives.

Conclusion

Floating-rate bonds have the potential to pay high interest if rates increase in the market, but that also comes with risks. Investing wisely is always advisable. IIFL’s professionals can help you select the right bonds and strategies to get maximum returns. Check out IIFL’s website or download IIFL Markets’ app to learn more about bonds and how to increase your profits while keeping your portfolio healthy.

Frequently Asked Questions

1. Do floating rate bonds have interest rate risk?

Yes, floating-rate bonds may have interest rate risk. This is because the interest rate of the floating rate bond may not rise as fast as the market interest rates in a rising interest rate environment. It all entirely depends on the performance of the benchmark rate. If the performance is not par, the floating rate bond may underperform the overall market.

2. How often are the floating rates adjusted?

The adjustment time of any floating-rate bond is pre-specified in the bond details. The adjustment time differs from bond to bond. Some issuers adjust the floating rates quarterly, some semi-annually, and the rest may do it annually.

3. Are floating-rate bonds a good investment?

Floating-rate bonds are a good investment if you want protection against increasing interest rates because their return is revalued on the basis of market rates. They guarantee a smooth income and lower interest rate risk, but could yield smaller returns when rates are steady or declining. Hence, consider your risk-bearing capacity and market expectations before investing.

4. Why issue floating-rate bonds?

Floating rate bonds are used by companies and governments when there are volatile interest rate conditions. They have the impact of lessening long-term interest rate risk and coordinating returns with market rates. They are attractive when fixed-rate lending would be costlier or less desirable to investors.

5. Which is better, fixed rate or floating rate?

The decision is based on market conditions and your objectives. Fixed-rate bonds offer fixed returns, which are great in low-interest-rate situations. Floating rate bonds move with the market rate, hedging against increases in the rate, but are less stable in decreasing rate situations. Decide according to your risk tolerance and interest rate expectation.