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An Investment Guide to Floating Rate Bank Loans

Conventional wisdom is that an increase in the target Fed funds rate leads to an imme- diate increase in market interest rates, and a fall in bond prices; yet evidence for this view is elusive. Cook and Hahn (1989) documented a strong response in the 1970s, but regressions using data from the 1980s and 1990s show little, if any, impact of Fed policy on interest rates. Roley and Sellon (1995), for example, conclude that “although casual observation suggests a close connection:::, the relationship between Fed actions and long-term interest rates appears much looser and more variable.” These studies did not distinguish between anticipated and unanticipated actions, however,. | Pioneer Perspectives An Investment Guide to Floating Rate Bank Loans A floating-rate loan is a debt obligation whose interest rate is tied to another rate such as the Prime rate or the London Interbank Offered Rate LIBOR . Because the loans are senior and secured they typically provide lenders with the first right to any cash flows from the sale of collateral in the event that the borrower defaults on its obligations under the loan. What are Floating Rate Bank Loans A floating-rate loan is a debt obligation whose interest rate is tied to another rate such as the Prime rate or the London Interbank Offered Rate LIBOR . They are also known as bank loans senior loans or leveraged loans. Floating rate bank loans are loans made by a bank or other lender to a company typically secured by the assets of the borrower. Proceeds of the loans are often used to finance leveraged buyouts recapitalizations mergers acquisitions stock repurchases and other transactions. Although the loans are typically backed by specific collateral such as property plant equipment or subsidiary stock the loans often carry a below-investment-grade rating and are therefore subject to greater risk of default than investment-grade securities. Because the loans are senior and secured they typically provide lenders with the first right to any cash flows from the sale of collateral in the event that the borrower defaults on its obligations under the loan. As a result lenders historically have recovered a high proportion of their outstanding loan amount approximately 70 if the company has defaulted as compared to unsecured obligations such as bonds of the same issue approximately 35 . The rate of the loan is reset periodically often taking place every 30 60 90 or 180 days. Floating rate loans tend to receive a lot of attention in times when investors expect interest rates to rise because investors believe their performance is inversely correlated to the overall bond market. However as the table on the .