Floating-rate bonds and fixed-rate bonds do not share one interest-rate risk

explainerPublished 19 October 20262 min readfixed income

Key points

• A floating coupon reduces exposure to the general level of the reference rate. It does not remove the spread.
• A fixed-rate bond’s price moves more, for a given change in yield, when its cash flows are further away.
• The arithmetic below is hypothetical. It is not a fund, a yield or a market print.

What is going on

Interest-rate duration summarises how much a bond’s price changes when the yield used to discount it changes. A common approximation is that the percentage price change is about minus modified duration times the yield change in percentage points. A floating-rate note resets the coupon, so the price tends to stay nearer par when only the reference rate moves, until the next reset. The spread over that reference rate is a separate price. If lenders demand more spread, the floater can fall even though the coupon will reset.

Why it matters

Rate cuts and rate rises are not mirror images of a single ‘bond’ return. A long fixed-rate government bond gains when required yields fall and loses when they rise. A floater’s coupon falls when the reference rate falls, which can disappoint a buyer who wanted income, even if the price is stable. A bill has little credit spread if it is a government bill. A corporate floater is not a bill.

What to watch

Name the reference rate, the reset frequency, the maturity and the issuer. Watch the spread, not only the policy rate. The policy-rate notes elsewhere on this site describe central-bank decisions. They are not a price for a corporate loan.

Risks

The duration approximation ignores convexity and the passage of time. It is worse for large yield moves and for bonds with embedded options. A cap or a floor on a floating coupon changes the payoff. Liquidity in a reset can be thin.

A labelled illustration

This worksheet is hypothetical. Suppose a fixed-rate bond has a modified duration of 8. A rise of 1 percentage point in yield corresponds to an approximate price change of minus 8 percent. Suppose a note that resets quarterly has a modified duration of 0.25. The same 1 percentage point rise corresponds to about minus 0.25 percent from the reference-rate move alone. If, in addition, the credit spread on the floater widens by 2 percentage points and the spread duration is 4, the spread piece is about minus 8 percent. The floater is then not the ‘safe’ one. These durations were chosen to show the arithmetic. They are not a published fund factsheet.