Floating Rate Notes (FRNs) Field Guide 2024

Larry, Managing Editor

floating rate notes FRNs guide

In an environment where interest rates are volatile or expected to rise, investors and savers typically want to buy investments that provide protection and return from these rising rates. One such investment is floating rate notes, also known as FRNs.

U.S. Treasury FRNs are debt investments with a variable interest rate tied to an index rate, the latest 13-week U.S. Treasury Bill rate. When this T-Bill rate increases, the FRN interest rate will also adjust accordingly and provide investors the chance to earn higher coupon payments. 

In this Field Guide, we will be referring to FRNs that are issued by the U.S. Treasury and not FRNs that are issued by other entities, such as banks, financial institutions, and corporate entities.

Why you should care:

  • Floating rate notes (also known as FRNs or floaters) offer investors protection against rising interest rates and can generate increased yields in a rising rate environment.

What you should know:

  • FRNs have a variable rate component tied to the most recent new-issue 13-week T-Bill rate. When the T-Bill rate fluctuates, the FRN interest rate fluctuates as well. Rising rates are advantageous to FRN holders.
  • The other component of the FRN interest rate is the “spread”, which is a fixed rate set by U.S. Treasury at the time of an FRN auction. Adding the spread to the 13-week T-Bill rate gets you the FRN rate.
  • FRNs, like other Treasuries, are backed by the full faith and credit of the U.S. government. This means that the default risk of FRNs is basically zero.

To learn more about FRNs, continue reading the Field Guide.

What Is a Floating Rate Note?

A Floating Rate Note (FRN) is a debt instrument that pays interest at a variable rate, which adjusts periodically based on a reference or index interest rate, such as the London Interbank Offered Rate (LIBOR) or the U.S. Treasury bill rate.

U.S. Treasury FRNs were introduced in 2014. These are 2-year notes that pay interest quarterly (every three months). Like other Treasuries, U.S. Treasury FRNs are exempt from state and local taxes. Federal taxes on FRNs must be paid every year.

Unlike fixed-rate bonds, which pay a constant interest rate throughout their life, the interest payments on FRNs adjust in response to fluctuations in the underlying index rate, which is the 13-week T-Bill rate.

As a result, FRNs not only protect investors in an environment with rising interest rates but will also provide a higher return from increased coupon payments.

How Do Floating Rate Notes Work?

U.S. Treasury floating rate notes have an interest rate comprised of an index rate and spread. The index rate will adjust weekly based on changes in the interest rates while the spread is fixed. Let’s walk through each component:

  1. Index Rate: The interest rate on an FRN is tied to an index rate. For U.S. Treasury floating rate notes, this index rate is the highest discount rate of the most recent 13-week Treasury Bill. Because new-issue 13-week T-Bills are auctioned every week, the index rate of the FRN is also reset every week.
  2. Spread: In addition to the index rate, the U.S. Treasury will pay an additional fixed percentage, known as the spread. This spread is fixed for the life of an FRN and determined at the time of auction.
  3. Interest Reset Period: The interest rate on an FRN adjusts every week based on the changes in the 13-week Treasury Bill rate.

Interest is paid every three months until maturity, but interest payments are calculated daily.

Floating Rate Note Example:

Let’s walk through an example of floating rate notes with some illustrative numbers.

Let’s say you buy an FRN with a principal amount of $1,000. The interest rate on this FRN is determined by the 13-week Treasury Bill rate plus a spread of 0.125%.

  1. Initial Interest Payment:
    • At the time of purchase, let’s assume the 13-week Treasury Bill rate is 5.5%.
    • The interest rate for the FRN would be 5.5% (13-week T-Bill rate) + 0.125% (spread)= 5.625%.
    • Since the interest is calculated daily, the interest payment for that week is approximately $1.09, or $1,000 times the interest rate of 5.625% times seven (the number of days in a week) divided by 360 (the number of days used for annual calculations). 
  2. Subsequent Interest Payment:
    • After a week months, suppose the 13-week T-Bill rate rises to 5.6%.
    • The new interest rate for the FRN would be 5.6% (13-week T-Bill rate) + 0.125% (spread)= 5.725%.
    • Since the interest is calculated daily, the interest payment for that week is approximately $1.11, or $1,000 times the interest rate of 5.725% times seven (the number of days in a week) divided by 360 (the number of days used for annual calculations). 

As illustrated, when the index rate of the 13-week Treasury Bill rises, the interest payment on the FRN also increases. This mechanism allows FRN holders to benefit from rising interest rates, unlike fixed-rate bondholders, who receive a constant interest payment regardless of market rate fluctuations.

What Happens to a Floating Rate Note When Interest Rates Go Down?

Because the interest rate of a floating rate note is tied to the 13-week T-Bill interest rate, if the T-Bill rate goes down, then the interest rate on the FRN will also decline.

How Is The Spread Calculated?

The spread for Floating Rate Notes (FRNs) represents the margin added to the index rate to determine the total interest rate payable on the note. 

The spread for U.S. Treasury FRNs is determined at the time of the initial auction. It remains fixed for the life of the note.

During the auction, bids are placed by participants, and the spread is set at the highest rate at which the quantity of offered notes will be fully awarded. This means that all successful competitive and non-competitive bidders receive the FRN at the same spread.

The spread is added to the index rate (e.g., the high yield of the most recent 13-week Treasury bill auction) to determine the interest rate for the upcoming period.

How Do Investors Use Floating Rate Notes in a Portfolio?

Floating rate notes offer investors protection against rising interest rates due to their ability to adjust coupon payments in line with market interest rates. Like other Treasuries and fixed-income securities, FRNs pay a stable income stream, but FRNs have the potential for increased coupon payment income if interest rates rise.

We think FRNs are a nice cash complement since they’re backed by the full faith and credit of the U.S. government, so there’s effectively no default risk. As a result, it can be a viable alternative to holding cash in a regular bank or savings account for some savers and investors.

What Are the Tax Implications of Floating Rate Notes?

Interest income from U.S. Treasury floating rate notes is exempt from state and local income taxes. However, it is still subject to federal income tax. This must be paid annually.

If you sell or redeem an FRN for more than your purchase price (or adjusted basis), you’ll have a capital gain. Conversely, if you sell or redeem it for less than your purchase price, then you’ll have a capital loss. If held for one year or less, it’s a short-term capital gain or loss. If held for more than one year, it’s a long-term capital gain or loss.

What Are the Auctions Dates for Floating Rate Notes?

The auctions for floating rate notes are announced in the second half of January, April, July, and October (once every three months).

Reopening auctions of a 2-year FRN are announced in all other months of the year. The announcements occur in the second half of February, March, May, June, August, September, November, and December. 

A reopening auction is when the U.S. Treasury issues additional amounts of a previous FRN. 

Here is a handy table outlining the FRN auction schedule:

New-Issue FRN Auction MonthsFRN Reopening Auction Months 
JanuaryFebruary, March
AprilMay, June
JulyAugust, September
OctoberNovember, December

All floating rate notes issued in reopening auction months will have the same CUSIP number, maturity date, and spread as the FRNs in the most recent new-issue auction.

An FRN issued in the months of the right-hand column will be exactly the same as the FRN issued in the month of the corresponding column on the left, with the exception of a potential difference in purchase price.

The U.S. Treasury auction schedule will also show you the exact dates for when new-issue FRNs will be issued or reopened.

What Are The Risks of Floating Rate Notes?

Like Treasury bills, notes, and bonds, floating rate notes are backed by the full faith and credit of the US government. Therefore, the default risk of U.S. Treasury floating rate notes is virtually none.

There are certain things to consider when you buy FRNs:

  • FRNs are a less effective interest when interest rates fall. Because an FRN is tied so closely with the 13-week T-Bill rate, any drop in the rate will result in a lower coupon payment for the investor.
  • The spread in FRNs is not always positive. For example, the spread on 2-year FRNs issued in April 2022 had a negative spread of -0.075%. In that case, the yield on this FRN would always be lower than the yield of the current 13-week Treasury bill!
  • FRNs sometimes may not have a very liquid secondary market. While you can technically sell FRNs before maturity, the market for selling FRNs is not as liquid as for T-Bills or brokered CDs.

How Can I Buy Floating Rate Notes?

You can purchase floating rate notes through TreasuryDirect, or through your bank or brokerage.

To buy floating rate notes in TreasuryDirect, log into your account on TreasuryDirect and click the BuyDirect tab. Follow the prompts to buy FRNs, specify the purchase amount, and other information.

To buy FRNs in your brokerage account, such as Fidelity, E*Trade, or Vanguard, you can typically find the option to buy U.S. Treasury FRNs in the Fixed Income or Bonds section. Look for new-issue Treasuries, under which new-issue FRNs should show up if they have been announced.

You can always reference the U.S. Treasury auction schedule to look at when new-issue FRNs will be issued or reopened.

FAQ

How do FRNs differ from fixed-rate notes?

The main difference between FRNs and fixed-rate notes is that the interest rate on FRNs is not fixed for the entire term of the bond. Instead, it fluctuates based on changes in the benchmark rate. In contrast, fixed-rate notes have a predetermined interest rate that remains fixed throughout the life of the bond.

Who can invest in FRNs?

A: Individual investors can invest in FRNs through TresauryDirect, online brokerages, banks, ETFs or other investment vehicles. Anyone who meets the eligibility requirements of the issuer can invest in FRNs. Institutional investors, such as banks, insurance companies, and mutual funds, also invest in FRNs.

What is the benchmark rate for FRNs?

The benchmark rate for U.S. Treasury FRNs is the most recently auctioned 13-week Treasury Bill rate.

Can the interest rate on an FRN change?

Yes, the interest rate on an FRN can change. U.S. Treasury FRNs adjust every week due to new-issue 13-week T-Bill auctions occurring weekly.

How does the interest rate adjustment affect the value of an FRN?

The interest rate adjustment can affect the value of an FRN. When interest rates rise, the value of an FRN can decrease as the fixed interest payments become less attractive compared to the higher prevailing market rates. Conversely, when interest rates fall, the value of an FRN may increase as the fixed interest payments become more favorable.

However, since U.S. Treasury FRNs adjust coupon payments with market rates, the prices typically remain relatively stable.

Can an FRN offer higher interest rates compared to fixed-rate bonds?

Yes, an FRN can offer higher interest rates compared to fixed-rate bonds, especially during periods of rising interest rates. Since the interest rate on an FRN is tied to an index rate, it can increase as the index rate rises. This can make FRNs attractive for investors seeking higher yields in a rising rate environment.

Do floating rate notes (FRNs) protect against inflation?

FRNs will primarily protect investors from rising interest rates. While FRNs may offer some protection against inflation, other bonds, such as I Bonds and TIPS, will do a better job of directly protecting investors from inflation.