Floating rate securities

Although we can see that for fixed rate corporate bonds, spread duration and effective
duration are the same, for floating rate notes (FRNs), this is not the case. The effective
duration of an (uncapped) FRN is roughly equal to the amount of time to its next
reset date. For example, an FRN with a monthly reset would have an effective
duration of approximately 0.08, indicating the security has very little interest rate
sensitivity. However, since a change in secondary spreads does not cause the FRN’s
coupon rate to change; a FRN can have substantial spread risk. This is due to the
impact of a change in secondary spreads on the value of the remaining coupon
payments – if spreads widen, the FRN’s coupon will be below the level now demanded
by investors, so the present value of the remaining coupon payments will decline.
The greater the time to maturity, the longer the series of below-market coupon
payments paid to the investor and the greater the decline in the value of the FRN.
Therefore, the spread duration of an FRN is related to its time to maturity; e.g. an
FRN maturing in two years has a lower spread duration than an FRN maturing in
ten years.