Floating Rate Bonds in India

Most bonds work like a fixed deposit: you lock in a rate, which is what you’re entitled to earn for the entire term. A floating-rate bond works a bit differently. The interest it pays doesn’t stay fixed. It rises and falls based on a benchmark rate set by the government (RBI) or the market itself. When that benchmark goes up, your coupons increase. When it dips, your coupons decrease.

Think of it this way: a fixed-rate bond is like a job with a fixed salary. Predictable, but a raise is out of the question even if the market is booming. A floating-rate bond is like a job where your salary is reviewed every few months and can go up and down accordingly.

How is the coupon rate calculated?

Every floating rate bond has a simple formula:

Your coupon = Benchmark rate + Spread

The benchmark rate is the reference rate your bond is tied to. In India, this is usually:

• The NSC (National Savings Certificate) rate—Used by RBI’s Floating Rate Savings Bonds for retail investors
• The 91-day T-bill yield rate- Used in G-Secs (Government Securities)
• MIBOR (Mumbai Interbank Offer Rate) - Used in corporate floating rate bonds

The spread is a fixed premium that stays constant throughout the bond’s life and reflects the extra return the issuer needs to offer.

For example: If the NSC rate is 7.5% and the spread is 0.35%, your coupon is 8.05%. The benchmark rate is reset periodically (quarterly, semi-annually, annually), depending on the specific bond’s terms.

Types of floating-rate bonds available in India

Here’s a breakdown of the options available for Indian investors:

For most retail investors in India, the RBI Floating Rate Savings Bond (FSRB) 2020 is the most relevant one. It is simple, sovereign-backed, and easily accessible through most of the banks and RBI Retail Direct.

Floating rate vs fixed rate bonds

Both the types are a good choice depending on the market environment.

• When rates are rising, floating rate bonds take the lead. Your coupon keeps riding the surge wave, while someone holding a fixed-rate bond is stuck with their old, lower fixed rate.
• When rates are falling, fixed-rate bonds come at the top. Since you locked in a higher rate early, your coupon will stay ahead of the current rates the market is offering. A floating-rate bondholder, on the other hand, sees their coupon diminishing in value with every reset.

One more reason investors prefer FRBs in certain environments is the duration risk. Fixed rate bonds are quite sensitive to interest rates, whereas floating rate bonds are not. If the interest rates rise, a fixed-rate bond will lose value. A floating-rate bond will adjust the coupon accordingly, keeping the principal value stable.

Who should invest in floating-rate bonds

• Conservative investors who want the opportunity if better returns than a savings account with the additional security of being backed by the government

• Investors in a rising or uncertain rate environment looking to ride the ups and downs and not ending up with a fixed rate that might not be competitive

• Retirees and senior citizens who are aiming for a steady source of income. FRSB 2020 even allows premature withdrawal after a few years into the term of the bond

That being said, they may not be the best fit for

• Investors who might need to sell before maturity

• Those expecting the market to undergo a sharp rate cut

What are the risks associated with floating-rate bonds?

They are often considered low risk, but that doesn’t mean risk-free. Here’s what you should bear in mind:

• Income variability—Your coupon depends on the market rates and will fall if the rates do.

• Liquidity risk—FRSB 2020 cannot be sold on a secondary market. Once you choose to invest, a lock-in period of 7 years is in place, with partial exit options for senior citizens

• Credit risk—Government FRBs carry no default risk. Corporate FRBs do. Don’t fall for the high-yield trap. Always go deeper than an issuer’s credit rating when you research.

• Inflation risk—If inflation rises ahead of your floating coupon, your returns could turn negative.