Floating Rate Bonds: How They Reset

What Exactly Is a Floating Rate Bond?

A floating rate bond is a fixed-income security whose coupon, or interest payment, is not set permanently at the time of issuance. Instead, the coupon is recalculated at predetermined intervals using a formula that links it to a reference rate - often called the benchmark - plus an additional margin known as the spread.

The core logic is elegant: because the coupon tracks market rates, the bond's cash flows adjust automatically to the prevailing cost of money. This means a holder is, in theory, never locked into a rate that is grossly out of step with what the market is offering. In contrast, a holder of a fixed-rate bond issued when interest rates were low will continue to receive that lower coupon even as the RBI raises its policy repo rate and newer bonds pay more.

To understand the anatomy of a floating rate bond, consider its four key components. First, the benchmark rate - this is the external reference to which the coupon is anchored. In the Indian government securities market, benchmarks have included the 91-day Treasury Bill yield, the 182-day Treasury Bill yield, the weighted average yield of Treasury Bills from a specific auction, or the yield on a specific dated government security. In global markets, benchmarks like LIBOR were historically used, though the transition to SOFR in the US and SONIA in the UK has made benchmark selection a more nuanced matter. In India, the RBI has been careful to anchor government floaters to Indian market rates.

Second, the spread - this is the fixed additional margin added to the benchmark to arrive at the final coupon. For example, if the benchmark is 6.50% and the spread is 0.25%, the coupon for that reset period is 6.75%. The spread is determined at issuance and does not change over the bond's life. A higher spread generally indicates either a longer maturity, lower credit quality, or lower liquidity premium that the issuer must pay.

Third, the reset frequency - this specifies how often the coupon is recalculated. Common frequencies are quarterly (every 90 days), semi-annual (every 180 days), or annual. Some short-term floaters reset monthly. The more frequent the reset, the more tightly the bond's coupon tracks current market rates, and consequently the more stable its price tends to be.

Fourth, the day-count convention - this determines how interest is accrued between payment dates. In Indian government securities, the Actual/365 convention is standard, meaning interest is calculated as (Coupon Rate × Face Value × Actual Days) ÷ 365. Understanding this matters when calculating accrued interest on a settlement date that falls between coupon payment dates.

It is also worth distinguishing between a true floater and a step-up bond. A step-up bond increases its coupon at predetermined dates but by a fixed amount agreed at issuance - the increase is mechanical, not tied to any external rate. A floater's coupon increase or decrease depends on what happens in the market. Similarly, a capped floater has an upper limit on how high the coupon can go, while a floored floater has a lower limit - often zero or some minimum rate - below which the coupon will not fall even if the benchmark does.

The Indian Government Floating Rate Bond Landscape

India's floating rate bond market has evolved meaningfully since the Government of India issued its first floating rate dated securities in the early 2000s. Today, two broad categories of government floaters exist for Indian investors: sovereign dated securities available primarily to institutional investors through the NDS-OM platform, and the Floating Rate Savings Bond (FRSB) aimed specifically at retail savers.

The Floating Rate Savings Bonds, 2020 (Taxable) - commonly referred to as RBI Floating Rate Savings Bonds - were introduced by the Government of India in July 2020 to replace the erstwhile 7.75% Savings Bonds. What made them distinct was their explicit link to another popular small savings scheme: the National Savings Certificate (NSC) rate. The coupon on these bonds is reset every six months - on 1 January and 1 July each year - and is always set at 35 basis points (0.35%) above the prevailing NSC rate. This design ensures the retail investor benefits when the government raises small savings rates, which typically follow broad interest rate movements.

For institutional participants, the RBI periodically auctions floating rate dated government securities with maturities ranging from short to medium term. The benchmark for these securities has varied across issuances but has commonly been the weighted average yield of 91-day Treasury Bill auctions conducted during a defined reference period before the reset date. The RBI announces the reset date, the reference period, and the methodology in the bond's prospectus or the relevant government notification, ensuring full transparency.

One important feature of government floaters in India is their sovereign credit quality. Since both the dated securities and the Savings Bonds are backed by the Government of India, there is no credit default risk - meaning the risk that the issuer will fail to pay interest or principal. This makes them fundamentally different from corporate floating rate notes, where the credit risk of the issuing company is an additional variable to evaluate.

The settlement of floating rate dated securities in India happens through the RBI's own settlement infrastructure. Institutional trades on NDS-OM settle on a T+1 basis through the Public Debt Office (PDO), and the bonds are held in the Subsidiary General Ledger (SGL) maintained by the RBI. Retail investors accessing G-secs through the RBI Retail Direct platform can also hold these securities in their RGL (Retail G-sec) accounts. Since the introduction of the Retail Direct scheme, individual investors can participate in primary auctions and secondary market trading of government securities, including floaters, without going through a broker.

It is important to note that the liquidity profile of floating rate dated securities can differ from that of benchmark fixed-rate G-secs like the 10-year bond. Floating rate issues may have thinner secondary markets on certain days, and the bid-ask spread can be wider. Investors who may need to exit before maturity should factor this liquidity consideration into their decision-making.

Beyond sovereign instruments, the corporate bond market in India also features floating rate notes (FRNs) issued by banks, non-banking financial companies (NBFCs), and public sector undertakings. These typically use benchmarks such as the Mumbai Interbank Forward Offer Rate (MIFOR), the RBI repo rate, or MIBOR (Mumbai Interbank Offer Rate). Corporate FRNs carry credit risk in addition to interest rate risk, and SEBI regulations require them to carry a credit rating. Investors comparing government and corporate floaters must weigh the higher yield of corporate FRNs against their additional risks.

How the Reset Mechanism Works Step by Step

The reset mechanism is the heartbeat of a floating rate bond. Understanding it in detail removes mystery and helps investors predict their next coupon with reasonable accuracy.

The reset process begins with the reset date - the specific calendar date on which the new coupon is calculated and takes effect. For the RBI Floating Rate Savings Bonds, the reset dates are fixed at 1 January and 1 July each year. For floating rate dated G-secs, the reset dates are specified in the issuance document and typically coincide with coupon payment dates, so the reset coupon is applied going forward.

Before the reset date, there is a reference period - a defined window during which the benchmark rate is observed and averaged. For instance, if the benchmark is the 91-day T-Bill yield, the reference period might be the four auctions immediately preceding the reset date. The RBI calculates the weighted average cut-off yield from those auctions, rounds it to the nearest basis point per the prospectus formula, and then adds the predetermined spread to arrive at the new coupon.

Once the new coupon is determined, it is announced publicly. For government securities, the RBI publishes this on its website and through official notifications. The new coupon applies to the interest period beginning on the reset date and lasting until the next reset date.

Consider a simplified timeline: a floater with a semi-annual reset has reset dates on March 1 and September 1. The interest period from September 1 to February 28 will use the coupon set on September 1. The interest period from March 1 to August 31 will use the coupon set on March 1. On each reset date, the RBI looks back at the reference period, calculates the new benchmark, adds the spread, and announces the coupon for the next six months. Investors receive their coupon payment at the end of each interest period - in this case, on February 28 and August 31.

A critical subtlety: when you buy a floating rate bond in the secondary market between two reset dates, you do not know what the next coupon will be. You know the current coupon (the one in force for the current period), and you can make an educated estimate of the next one if you watch the benchmark rate, but you cannot know it with certainty. This uncertainty is the trade-off you accept for interest rate protection.

Another subtlety is the concept of in arrears versus in advance reset. Most floaters use an in-arrears structure where the benchmark is observed during a reference period that ends just before the reset date. Some structures, however, use an in-advance approach where the benchmark for the next period is set at the beginning of that period (i.e., observed before the current period even begins). In-arrears resets are the norm for Indian government floaters.

For the RBI Floating Rate Savings Bonds specifically, the reset mechanism is slightly different from market-linked dated securities. The coupon is not directly tied to a market-traded rate but to the NSC rate, which is an administered rate announced by the government, typically in line with the broader interest rate environment. This makes the FRSB's reset somewhat smoother and more predictable - the coupon changes only when the government officially revises the NSC rate, which may not coincide with every RBI policy rate change.

Investors should always read the prospectus or information memorandum of any floating rate bond they purchase. The prospectus will specify the exact benchmark, the reference period, the reset frequency, the spread, the day-count convention, and any caps or floors on the coupon. These details are legally binding and form the foundation of every coupon calculation for the life of the bond.

Pricing a Floating Rate Bond in the Secondary Market

Pricing a floating rate bond in the secondary market is subtler than it first appears. Because the coupon changes with each reset, the traditional bond pricing formula - discounting a series of fixed cash flows - does not apply directly. A different approach is needed.

The theoretical price of a floating rate bond on a reset date (when the new coupon has just been set and accrued interest is zero) should be very close to its face value, or par. This is because the coupon for the new period already reflects the current market rate for instruments of similar credit quality and maturity. There is no mismatch between what the bond pays and what the market requires, so the bond trades at par.

The price can deviate from par for several reasons. First, if the spread embedded in the bond does not match what the current market demands for the same credit quality and maturity, the bond will trade at a discount or premium. For instance, if a bond was issued with a spread of 0.25% over T-Bills but market conditions now demand 0.50% for similar bonds, the bond will trade below par to compensate buyers with an additional return. Second, between reset dates, the coupon is fixed (at the rate set on the last reset date), so for the remainder of the current period, the bond behaves like a short-term fixed-rate instrument. If rates have moved sharply since the last reset, a small price deviation from par is possible.

Third, credit quality changes - relevant for corporate floaters - can cause significant price deviations. If an issuer's credit rating is downgraded, the spread demanded by investors increases, and the bond's price falls even if interest rates have not changed.

In the Indian G-sec market, floating rate dated securities are quoted in terms of yield on NDS-OM, similar to fixed-rate G-secs. The yield quoted for a floater, however, is typically expressed as a spread over the benchmark rather than as an absolute yield number. A trader might quote a floater as "benchmark + 12 bps" meaning the buyer is willing to earn 12 basis points above the current benchmark rate. The actual rupee price is then derived from this spread and the current benchmark value.

Accrued interest also plays a role. When a bond is bought on any day that is not a coupon payment date, the buyer must compensate the seller for the interest accrued since the last coupon payment. For floating rate bonds, accrued interest is calculated using the current (in-force) coupon rate and the actual number of days elapsed since the last coupon payment, using the Actual/365 day-count convention applicable to Indian G-secs.

Retail investors accessing G-sec floaters through the RBI Retail Direct platform or through a demat account on NSE/BSE (where some G-sec instruments are listed for retail access) should be aware that the quoted price on screen is the clean price - it does not include accrued interest. The total amount you pay is the dirty price, which equals clean price plus accrued interest. Not understanding this can create confusion if your broker account statement shows a price different from what you expected to pay.

Floating Rate Savings Bonds vs Floating Rate Dated G-Secs

Indian investors often encounter two distinct types of floating rate instruments backed by the Government of India, and it is worth understanding how they differ before deciding which, if either, suits their needs.

The Floating Rate Savings Bonds (FRSB), 2020 (Taxable) are designed explicitly for retail savers. They can be purchased by resident Indian individuals (either singly or jointly), Hindu Undivided Families (HUFs), and charitable institutions and universities. Non-resident Indians (NRIs) are not eligible. The minimum investment is ₹1,000 (and in multiples of ₹1,000 thereafter), with no upper limit. The bonds have a tenor of 7 years from the date of issue, and premature withdrawal is permitted only for specified categories of senior citizens after a minimum lock-in period.

The coupon on FRSBs resets every six months (on 1 January and 1 July) and is pegged at 35 basis points above the NSC interest rate. Since NSC rates are revised by the government periodically (often but not always quarterly), the FRSB coupon captures changes in the administered rate environment. Interest is paid semi-annually directly to the investor's bank account. The bonds are issued in dematerialised form and held in Bond Ledger Accounts (BLAs) maintained with the Receiving Office (typically authorised banks).

Floating rate dated government securities, on the other hand, are standard marketable G-secs issued by the Government of India through the RBI's auction process. They have maturities that can range from a few years to over a decade. Their benchmark is typically a market rate - the 91-day or 182-day T-Bill yield, or occasionally the weighted average yield of recent G-sec auctions. The spread is determined through the auction process itself (competitive bidding). These securities are fully transferable and tradeable on the secondary market through NDS-OM or through the exchange platform.

For retail investors, the key practical differences are: FRSBs offer simplicity and sovereign safety with a predictable reset formula, but they are not tradeable in the secondary market, meaning you are locked in until maturity (subject to premature withdrawal rules for eligible investors). Dated floaters offer full liquidity through secondary market trading but require either a demat account and understanding of the G-sec market, or access through the RBI Retail Direct platform.

From a yield perspective, dated floaters may offer different spreads depending on the issuance terms and prevailing market conditions. FRSBs offer a fixed spread over NSC, which may or may not be better than the spread available on a dated floater in any given period. Neither instrument is universally superior - the right choice depends on your investment horizon, liquidity needs, and comfort with market-linked pricing versus administered rate setting.

Both instruments are subject to income tax on the interest received. Interest from FRSBs and dated G-secs is added to the investor's total income and taxed at the applicable slab rate. There is no Tax Deducted at Source (TDS) on G-sec interest if the bonds are held in demat form, but investors are responsible for self-reporting and paying advance tax. For FRSBs, TDS may apply depending on the Receiving Office and the investor's category. Always refer to the latest Finance Act and consult a tax professional for your specific situation.

Comparing Floaters with Fixed-Rate Bonds and Inflation-Indexed Bonds

A floating rate bond occupies a specific niche in the fixed-income universe. To appreciate its role fully, it helps to compare it with two close relatives: fixed-rate government bonds and inflation-indexed bonds (also known as Inflation Linked Bonds or Capital Indexed Bonds).

Fixed-rate government bonds - the 6.79% GS 2034, for example, represents the type if not a specific recommendation - pay a coupon that never changes. You know exactly what cash flow to expect every six months and on maturity. This certainty is valuable for liability matching (pension funds matching future obligations to present assets) and for investors who want income predictability. The downside is duration risk: in a rising rate environment, the market value of your holding declines. If you hold to maturity, you receive exactly what was promised - but if you need to sell early, you may suffer a capital loss.

Floating rate bonds sacrifice that certainty in exchange for interest rate protection. Your income will vary with each reset, and in a falling rate environment, your coupon income will decrease. But your capital value remains relatively stable regardless of the direction of rates. The trade-off is cash flow uncertainty versus price stability.

Inflation-indexed bonds link the principal or coupon (or both) to a price index rather than a nominal interest rate. In India, Capital Indexed Bonds and later Inflation Indexed Bonds (IIBs) have been issued by the Government, linking principal to the Wholesale Price Index (WPI) or Consumer Price Index (CPI). These bonds protect against real purchasing power erosion - if inflation is 6%, the principal grows by 6%, and the fixed coupon is then applied to this higher principal. The investor's real return (return after inflation) is preserved.

Floating rate bonds and inflation-indexed bonds both address a kind of risk, but different kinds. Floating rate bonds address nominal interest rate risk - the risk that rates rise and your fixed coupon becomes uncompetitive. Inflation-indexed bonds address inflation risk - the risk that even if your nominal return looks good, rising prices erode its purchasing power. In an environment where inflation drives interest rates higher (as the RBI raises rates to combat inflation), both instruments would tend to help, but for different reasons and through different mechanisms.

For a retail investor building a fixed-income portfolio, the choice between these three categories is not binary. A blend of short-duration fixed-rate bonds (which also have low price sensitivity), floating rate bonds, and a small allocation to inflation-linked bonds might address multiple risks simultaneously. However, the optimal blend depends on your specific financial goals, tax situation, investment horizon, and your view of the macro environment - and is best determined with the guidance of a SEBI-registered investment adviser.

Corporate floating rate notes add credit risk into the comparison. A corporate FRN might offer a higher coupon spread than a comparable government floater, but the additional yield compensates for the possibility of default or rating downgrade. High-quality issuers (well-rated PSU bonds, for example) might offer only marginally more than sovereign rates, while lower-rated issuers offer substantially more. Retail investors should be cautious about reaching for yield in the corporate FRN space without understanding the credit implications thoroughly.

Tax Treatment of Floating Rate Bonds in India

Understanding how floating rate bonds are taxed in India is essential because the after-tax return - not the headline coupon - is what ultimately matters to the investor.

For interest income: Interest received from floating rate bonds is treated as income from other sources under the Income Tax Act, 1961. It is added to the investor's gross total income and taxed at the applicable income tax slab rate. Whether the coupon is 6% or 8%, every rupee of interest received is fully taxable in the year it is received (or accrued, if the investor follows mercantile accounting). There is no special exemption for government bond interest - unlike, say, tax-free bonds issued by certain infrastructure companies that had a specific exemption.

For capital gains: If you sell a floating rate dated government security in the secondary market before maturity, any profit arising from the sale (i.e., the difference between the selling price plus accrued interest received versus the purchase price plus accrued interest paid, adjusted for the cost) is treated as a capital gain. The taxation of capital gains from debt instruments depends on the holding period. For debt instruments, the classification as short-term or long-term capital gain, and the applicable tax rates and indexation benefits, are determined by rules that have evolved significantly in recent Budgets. Rather than quoting a specific rate that may already have changed, investors should refer to the latest Finance Act for current rules on short-term and long-term capital gains from listed and unlisted debt securities.

For TDS: Tax Deducted at Source rules for government securities and Savings Bonds are specific. For dated G-secs held in demat form and settled through the depository/RBI system, TDS is generally not applicable on coupon payments because the securities are listed government securities. However, for FRSBs, the Receiving Office may deduct TDS on interest payments if the amount exceeds the specified threshold under the relevant provisions of the Income Tax Act. Investors should check with their bank or Receiving Office about the applicable TDS treatment and submit Form 15G/15H if eligible and required.

For HUF and corporate investors: HUFs are taxed similarly to individuals. Domestic companies and other entities have their own tax treatment under the corporate income tax framework. Non-residents investing in Indian government bonds - though FRSBs are not available to NRIs - are subject to withholding tax provisions and applicable Double Tax Avoidance Agreements (DTAAs).

An important practical note: since the coupon on a floating rate bond changes with each reset, investors must carefully track the interest received in each financial year (April to March in India) and report it accurately. This is particularly important if the reset date falls mid-year and you receive portions of two different coupons in a single financial year. Maintaining a record of all coupon payments received, with dates, is good practice.

For investors accessing bonds through the RBI Retail Direct platform, the platform provides a transaction and interest statement that can be used for tax filing purposes. Investors using demat accounts should rely on the annual interest certificate issued by their depository participant or the bond issuer.

Floating Rate Bonds in a Portfolio: Practical Considerations

Knowing the mechanics of floating rate bonds is only the first step. The more practical question is: how should a retail investor in India actually use these instruments within a broader financial plan?

The most common portfolio application for floaters is as an interest rate hedge. When inflation is rising and there is a strong likelihood that the RBI will continue raising its policy repo rate, holding long-duration fixed-rate bonds exposes you to capital losses. Shifting a portion of your fixed-income allocation from long-duration fixed-rate bonds to short-duration floaters reduces the overall duration of your portfolio without abandoning fixed income altogether. You still earn bond-like returns but with much less sensitivity to rate changes.

For investors with a short to medium investment horizon - say, two to five years - floating rate bonds can be a practical alternative to rolling over fixed deposits repeatedly. Rather than locking into a fixed deposit for six months and worrying about the reinvestment rate at each rollover, a floater adjusts your coupon automatically. Of course, the comparison is not perfect: bank fixed deposits carry DICGC insurance up to the applicable limit, while bond prices can deviate slightly from par in the secondary market.

Asset-liability matching is another application. If you have a liability (say, a balloon payment due in five years) and you want to fund it with bonds, a floating rate bond with a five-year maturity helps ensure that the value of your bond holding stays close to face value regardless of rate movements, because the floater's duration is always close to the next reset date rather than the full five years.

For investors who are already heavily invested in equity through direct stocks or mutual funds, fixed-income instruments including floaters provide stability and diversification. In equity market downturns, fixed-income holdings tend to hold their value better, cushioning the portfolio. Government floaters specifically add sovereign safety to this stabilising role.

One practical consideration for retail investors is the minimum investment size. FRSBs start at ₹1,000, making them accessible. Floating rate dated G-secs in the primary auction market require minimum bids of ₹10,000 for retail investors on the RBI Retail Direct platform. In the secondary market on NSE's G-sec platform, the minimum lot size is typically ₹10,000 face value as well, though market prices may mean the actual cash outlay differs.

Another practical consideration is whether to hold floaters directly or through mutual funds. Several debt mutual funds - such as floater funds or low-duration funds - hold floating rate bonds as part of their portfolios. SEBI mandates that floater funds invest at least 65% of their assets in floating rate instruments. The advantage of the mutual fund route is professional management, diversification, and liquidity (units can be redeemed at NAV any business day). The disadvantage is that mutual fund returns are subject to fund manager decisions, expense ratios, and the tax treatment applicable to debt mutual funds (refer to the latest Finance Act for the current tax position on debt fund gains, which has changed significantly in recent years).

Finally, always consider your total financial picture - emergency fund, insurance coverage, short-term goals - before allocating to bonds of any kind. Floating rate bonds are not suitable for emergency funds (which should be in highly liquid instruments like liquid funds or savings accounts) or for capital that may be needed at a moment's notice. They are best suited for the medium to long-term, relatively stable component of your savings.

Example

Key benefits

How it works

1. 1
   Bond Issuance and Terms Set

   The Government of India (through the RBI) issues a floating rate bond specifying the benchmark rate, the fixed spread, the reset frequency, and the day-count convention in the prospectus or government notification.

2. 2
   Initial Coupon Determined

   At issuance, the initial coupon is set using the current benchmark rate plus the stated spread, and this rate applies for the first coupon period until the first reset date.

3. 3
   Reference Period Monitored

   As the reset date approaches, the RBI observes the benchmark rate (such as the weighted average cut-off yield of 91-day T-Bill auctions) over the defined reference period.

4. 4
   New Coupon Calculated and Announced

   On the reset date, the RBI calculates the new benchmark average, adds the spread, rounds per the specified formula, and announces the new coupon publicly on its website and through official notifications.

5. 5
   New Coupon Applied to Next Period

   The newly announced coupon rate is applied to the bond's face value for the upcoming interest period, and accrued interest begins accumulating at this new rate from the reset date.

6. 6
   Interest Payment Made to Investors

   On each coupon payment date (which coincides with the reset date for most Indian government floaters), the accumulated interest at the previous period's coupon rate is paid to all registered holders of the bond.

7. 7
   Process Repeats Until Maturity

   Steps three through six repeat at every reset date for the life of the bond; on maturity, the final coupon is paid along with the full face value of the bond to the holder.

Formula

New Coupon Rate = Benchmark Rate (averaged over Reference Period) + Fixed Spread
Interest for Period = Face Value × New Coupon Rate × (Actual Days in Period ÷ 365)

Key takeaways

Frequently asked questions

Related terms