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What Is a Floating Rate ETF?

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  • Written By: Alex Newth
  • Edited By: Angela B.
  • Last Modified Date: 05 September 2016
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A floating rate exchange-traded fund (ETF) is a financial instrument that is similar to the stock market, because an ETF’s interest rate can increase or decrease and follows financial metrics. The floating rate ETF bond can mature in a certain timeframe, depending on what type of bond investors want to purchase. While some floating rate ETF notes are for international markets, they are more commonly used for the domestic market of the country or region issuing the note. Advantages to using this ETF is that ETFs are usually inexpensive and investors may have better gains than with stocks if the interest rate rises; the disadvantage is that the interest rate may to decline.

Similar to a stock or share, a floating rate ETF note follows a certain metric, and the interest rate can increase or decrease depending on that metric. With a share, the metric is the stock market and the company attached to the share; the ETF commonly tracks an overall commercial metric that affects all or many companies. Companies that sell the ETF typically determine what metric it follows. Unlike a share, the ETF will mature and it typically cannot be sold until that point.

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Some institutions may accept a premature ETF, but they will typically pay less than face value. When a floating rate ETF matures, it can be sold for the full amount of the ETF plus any interest. An investor is able to pick when the ETF matures, with the quickest maturing ETF at one month and the slowest at five years. This date is normally selected with interest rates in mind; if interest rates are going to increase shortly, then one month may be selected, but if the investor believes interest rates will be up in several years, then a longer maturity may be selected.

A domestic market metric is commonly where a floating rate ETF is invested. At the same time, there are a few ETF notes that can be purchased for international markets. This becomes a matter of preference, because an international market may be doing better one year, and will yield a better ETF upon maturity, while the domestic market may be better the next year.

Unlike most bonds, which have a standard interest rate, a floating rate ETF rises and decreases. This means one of the advantages to investing in a floating rate ETF is that the investor may get more money for the note at maturity. The metric also can decline, making a possible disadvantage to using this note the possibility that the investor may lose money or make only a small gain.

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