Floating Rate Bonds (FRB): What are RBI Floating Rate Bonds, Type and How to Invest in FRB

Summary

This video explains the growing popularity of floating rate bonds, especially in response to rising interest rates set by central banks. Unlike fixed-rate bonds, floating rate bonds offer variable interest rates linked to benchmark rates like the repo rate, which can provide higher yields in a rising interest rate environment. The video explores the benefits of these bonds, such as lower volatility, higher yields, and inflation protection, along with risks like unpredictable returns and tax implications. It also guides viewers on how to invest in these bonds, whether through government-issued bonds, corporate bonds, or mutual funds.

Takeaways

• 😀 Since 2022, the Reserve Bank of India (RBI) shifted from an accommodative stance to tackling inflation, leading to hikes in repo rates and the cash reserve ratio, affecting yield curves and short-term bond prices.
• 😀 Floating rate bonds are gaining popularity in debt mutual funds, with their allocation growing almost five times compared to the previous year, as investors seek alternatives to fixed-rate bonds during rising interest rates.
• 😀 Floating rate bonds pay variable interest linked to a benchmark rate (like the repo rate), and the rate is reset at regular intervals, making them less predictable than fixed-rate bonds.
• 😀 These bonds are less volatile compared to fixed-rate bonds as their coupon adjusts to prevailing interest rate conditions, offering higher yields in a rising interest rate environment.
• 😀 Government-issued floating rate bonds (FRBs) are considered safe investments with no credit risk, and they offer inflation protection due to their adjustable coupon rates.
• 😀 Key limitations of floating rate bonds include unpredictable cash flows, taxable interest, reinvestment risk, non-tradability (for RBI bonds), and potential credit risk in corporate bonds.
• 😀 The RBI issued a 7.15% floating rate bond in 2020, with a coupon rate adjusted semi-annually based on the National Savings Certificate interest rate, providing an example of how these bonds function.
• 😀 Financial institutions and corporations are increasingly issuing floating rate bonds, with their issuance rising from 1% to over 5% of total bond issuances between 2019 and 2020.
• 😀 Investors can purchase floating rate bonds through platforms like RBI Retail Direct, NSE GoBID, or designated bank branches, with bonds being issued in electronic form and not tradable in the secondary market.
• 😀 For corporate-issued floating rate bonds, investors can buy them through brokers or online trading platforms, and should carefully assess yields, credit ratings, and terms before purchasing.
• 😀 Mutual fund floaters provide an alternative way to invest in floating rate bonds, offering diversification, better returns than short-term debt funds, and favorable taxation for long-term capital gains with indexation benefits.

Q & A

What are floating rate bonds and how do they differ from fixed-rate bonds?

Floating rate bonds are debt instruments where the interest rate (coupon) is variable and linked to a benchmark rate, such as the repo rate. Unlike fixed-rate bonds, which offer a constant interest, floating rate bonds' coupons adjust periodically based on changes in the benchmark rate, providing potentially higher returns in rising interest rate environments.

Why are floating rate bonds gaining popularity in recent years?

Floating rate bonds are becoming more popular because they offer protection against rising interest rates, which is a concern for fixed-rate bonds. With rates expected to rise, these bonds offer a more attractive option due to their adjustable interest rates, making them less volatile and potentially more lucrative.

What are the key benefits of investing in floating rate bonds?

The key benefits of floating rate bonds include reduced volatility due to periodic interest rate adjustments, potentially higher yields compared to fixed-income instruments, safety when issued by the government, and diversification within debt portfolios, which helps manage interest rate risk.

What are some of the risks or limitations associated with floating rate bonds?

The risks associated with floating rate bonds include unpredictable cash flows, as the coupon rate changes periodically, reinvestment risk for the interest income, taxation on coupon payments based on the investor's income tax slab, and credit risk in corporate-issued bonds, which can be mitigated by choosing highly-rated bonds.

How do floating rate bonds work in terms of interest rate adjustments?

The interest rate on floating rate bonds is linked to a benchmark, such as the repo rate or LIBOR, and is adjusted at regular intervals. This means that if the benchmark rate rises, the bond's coupon rate increases, providing investors with a higher return. Conversely, if the benchmark rate falls, the coupon rate decreases.

Can you explain how RBI-issued floating rate bonds work with an example?

An example of an RBI-issued floating rate bond is the RBI 7.15% bond, issued in 2020. The coupon rate is set at 0.35% above the National Savings Certificate (NSC) rate, which changes every six months. For example, if the NSC rate is 6.8%, the bond offers an interest rate of 7.15% annually. This rate is reset every six months based on the NSC rate.

What are the different types of floating rate bonds available in the market?

There are several types of floating rate bonds, including short-term and long-term floaters, government-issued bonds, corporate bonds, callable floaters, and non-callable floaters. The structure and features of these bonds can vary, but they all share the characteristic of having an interest rate that adjusts periodically.

How can investors buy government-issued floating rate bonds?

Investors can buy government-issued floating rate bonds through platforms such as the RBI Retail Direct account or the NSE GoBid platform. After completing the necessary KYC procedures and selecting the bonds, investors can pay online and the bonds will be credited to their Demat account. These bonds are not tradable in the secondary market.

What are the benefits of investing in floating rate bond mutual funds?

Floating rate bond mutual funds offer diversification, as they hold a mix of debt securities, and are open-ended, allowing investors to buy and sell at any time. These funds typically offer better returns than short-term debt funds and are less volatile than long-duration debt funds. They also provide tax advantages, such as long-term capital gains with indexation benefits.

How do investors determine the yield on floating rate bonds when buying in the secondary market?

When buying floating rate bonds in the secondary market, investors should not focus solely on the coupon rate. Instead, they should calculate the yield, which reflects the total return on investment based on the purchase price and the bond's coupon rate. The yield can vary depending on market conditions, bond maturity, and other factors.