What Is a Variable Rate Bond?

Variable rate bonds have a floating or variable interest rate, or coupon rate. The rate adjusts according to a predetermined formula outlined in the bond's prospectus or official statement. Variable rate bonds' market values fluctuate less than other bonds.

Taxable and Tax-Free Variable Rates

Variable rate bonds, or loans made by issuers to bondholders, or lenders, may yield taxable or tax-free coupon interest. Coupon interest must be paid to lenders twice per year. According to the Federal Reserve Bank of San Francisco, low interest coupon bonds make variable rate bonds more appealing to investors.

Variable Rate Demand Notes, a kind of variable rate bond, are long-term tax-free securities with a variable interest rate that may be returned at par value with one to seven days' notice to the issuer. Lenders provide their funds to valuable public projects.

Build America Bonds

Build America Bonds (BABs), issued by municipal governments, may have a variable rate coupon interest structure. These bonds, according to Internal Revenue Service, bear taxable interest.

Floating Coupon Interest

Variable rate bonds' coupon interest adjusts in accordance with an external barometer or index value. Some examples of coupon interest adjusters include foreign exchange rates or a variety of bond indices.

Interest Rate Trends

According to Eaton Vance Investment Managers, interest rates have steadily declined for 30 years as of 2010. Variable rate bonds help to preserve bond values if investors want to convert bonds to cash before maturity.

References

• Federal Reserve Bank of San Francisco: Variable Rate
• Internal Revenue Service: Variable Rate
• Financial Industry Regulatory Authority

Resources

• Institutions Eaton Vance: Thirty Years
• "International Financial Management;" Jeff Madura; 2009
• "Financial Markets and Institutions;" Jeff Madura; 2008
• "Strategic Facilities Planning;" Alan Walter Streiss; 2005