These were first issued during a period of extreme interest rate volatility in the late 1970s. Floating-rate bonds, which are also known as variable-rate bonds or simply floaters, are debt obligations with variable interest rates that are adjusted periodically (typically every one, six, or three months). The interest rate is usually fixed at a specified spread according to some reference rate, such as the MIBOR, LIBOR, 10 year benchmark paper etc., plus or minus a pre-specified quoted margin. The quoted margin is the additional amount that the issuer is ready to pay above the reference rate. It is often quoted in basis points (bps). The formula for the coupon rate is as follows:
Coupon rate = Reference rate + Quoted margin
For example, 3 month MIBOR rate is 8.50%. On the coupon reset date, the quoted margin is 150 basis points. Then the coupon rate will be:
Coupon rate = 8.50% + 150 bps = 10.00%
The quoted margin need not be a positive value. The quoted margin may be deducted from the reference rate. For example, let us say that the reference rate is the yield of 10-years Treasury security and the coupon rate is reset every 3 months based on the formula:
Coupon =10-years Treasury yield -50 basis points.
On the coupon-reset date, the 5-years Treasury yield is at 9%. Then the coupon rate is calculated as follows:
Coupon rate = 9.00% - 0.5% = 9.5%
It is necessary to understand the procedure for the payment and setting of coupon rate. Let us consider a floater where interest is paid semi-annually. On the coupon reset date, interest rate is calculated based on a formula. This is the interest the issuer agrees to pay at the next coupon date six month from now. In simple words, the coupon rate is determined on the reset date, but paid in arrears.
Mumbai Interbank Offered Rate (MIBOR)
London Interbank Offered Rate (LIBOR)