Floating Rate Bonds in India: Types, Benefits & How to Invest Online
When governments or companies need funds for projects or expansion, they often turn to bonds to raise money from investors. Sometimes, these bonds come with fixed interest rates, but other times, they offer something different—a rate that changes with the market.
This type of bond is called a floating bond, and it can be an attractive option for investors who want to keep pace with fluctuating interest rates.
What Are Floating Rate Bonds and How Do They Work?
A floating bond is a debt security in which the interest payments, or coupon rates, vary over time based on a benchmark interest rate, such as the RBI’s repo rate or government bond yields. Unlike traditional fixed-rate bonds that pay the same interest throughout their life, floating bonds adjust their coupon rates periodically—quarterly, semi-annually, or annually—according to market conditions.
When interest rates go up, floating bond payments also go up. This helps investors earn more and keep up with rising costs (inflation). But if interest rates go down, the payments from these bonds also drop. Because the payments change with interest rates, floating bonds can help protect investors from the risks of changing interest rates.
In a fixed-rate bond, when market interest rates go up, the bond’s price usually falls because new bonds offer higher returns. But with floating bonds, the coupon rate adjusts with the market rate, so the bond’s price remains more stable. This means investors receive variable income that reflects current market conditions without the bond’s price fluctuating as much as fixed-rate bonds.
For example, if a floating bond pays a rate based on a benchmark plus 1%, and the benchmark rate goes from 5% to 6%, the bond’s interest rate will go from 6% (5% + 1%) to 7% (6% + 1%) when it resets. This helps investors earn more when interest rates go up.
Types of Floating Rate Bonds
Floating bonds come in several varieties, each suited to different investor expectations and market conditions:
Floating-to-Fixed Rate Bonds
These start with a floating interest rate but switch to a fixed rate after a certain period. They are ideal for investors who expect interest rates to fall and want to lock in a fixed rate later.
Inverse Floating-Rate Bonds
These move opposite to the benchmark rate. The bond’s interest rate falls when the benchmark rises, and vice versa. Investors anticipating a drop in interest rates may find these appealing.
Step-Up Callable Bonds
These bonds have interest rates that increase over time according to a pre-set schedule. However, the issuer can call (redeem) the bond early. Rising rates benefit investors, but there’s a risk the issuer might redeem the bond before maturity.
Perpetual Floating-Rate Bonds
These bonds have no maturity date and pay interest indefinitely. The coupon rate adjusts with the benchmark. They suit investors seeking a steady income stream but with higher credit risk and price volatility.
Zero Interest Bonds
Zero interest bonds do not offer periodic interest payments. Instead, they are sold at a deep discount and repay the full face value at maturity. The investor's return is the difference between the purchase price and the face value of the investment.
Benefits of Investing in a Floating Bond
A floating rate bond is a crucial component of a diverse investment portfolio, especially in fluctuating rate environments. Here are some key benefits they serve:
- Lower Volatility: The prices of floating-rate bonds are less volatile than those of fixed-rate bonds and other fixed-income securities. Fixed-rate bond prices depend on the market interest rate, while the interest rates of floating-rate bonds fluctuate based on the changing market benchmark.
- High Returns: Floating-rate bonds provide returns through coupon payments and premiums to the face value. In rising-rate environments, they offer higher returns than other debt instruments. The returns are also higher with floating bonds due to the spread above the benchmark rate.
- Safety: Government bodies and corporate entities with high credit ratings issue these bonds. Therefore, there is minimal chance of default.
- Portfolio Diversification: Interest rates and stock market performance are inversely related. Therefore, they are the right instruments to balance an investment portfolio's risk profile. Those trying to diversify their portfolios may invest in these securities and earn good returns at low risk.
Steps to Invest in a Floating Bond
Investing in a floating bond is seamless. Let’s say you’re worried that interest rates might rise soon and want to earn better returns—floating bonds can be a smart choice. Here's how you can get started:
Identify the Issuing Entity
The government, private companies, and public sector undertakings may issue floating-rate bonds. Government bonds are the safest investment instruments due to their government backing and almost no chance of default. If investing in private company bonds, check their credit rating before investing.
Choose a Reliable Platform
You can buy floating bonds through banks, brokers, or online platforms. It is important to use a SEBI-regulated platform that offers secure demat holdings and direct credit of interest and principal to your bank account. Bondbazaar stands out by offering a wide selection of over 10,000 bonds, including government securities and corporate bonds, with zero account opening, brokerage, or maintenance charges.
Understand the Terms and Conditions
Examine the debt instrument’s reset frequency, spread, and benchmark rate. For instance, a bond with quarterly adjustments resets the interest rate every three months. Besides, check the charges applicable to bond investments. Bondbazaar levies no account opening, maintenance, or brokerage charges, enabling investors to save more.
Place the Order
Open a Demat account at a trusted platform, browse the available bond options, and select the bond worth investing in. After shortlisting the most favourable bonds, one must place the order based on the instrument's face value.
Monitor Regularly
Track the bond performance and interest rate changes to ensure it aligns with investment goals.
Why Consider Floating Bonds?
If you expect interest rates to rise in the future, floating bonds can help you earn better returns while reducing the risk of price drops seen in fixed-rate bonds. They offer a flexible income stream that adjusts with the market, making them valuable to a diversified portfolio.
With Bondbazaar, investing in floating bonds is convenient and cost-effective. You can buy and sell bonds at the click of a button, enjoy real-time trading, and benefit from expert support—all while earning attractive fixed returns typically between 8% and 14%*.
Conclusion
Floating bonds provide a smart way to stay ahead of changing interest rates while maintaining a relatively stable investment. Whether you’re a cautious investor looking for safety or seeking to diversify your portfolio with low-risk, high-return instruments, floating bonds deserve a place in your investment strategy. With easy access through Bondbazaar, you can confidently add these bonds to your portfolio and watch your investments grow with the market.