What is a Variable Rate Bond?

A variable rate bond is a bond whose stated interest rate varies as a percentage of a baseline indicator, such as the prime rate, plus a set percentage. Jumps in the baseline indicator can lead to substantial increases in interest rates, so this is a riskier form of financing for the issuer. The risk of higher interest rate costs can be mitigated by adding a redemption option to the bond agreement, whereby the issuer can choose to buy back bonds if interest rates increase to an excessive degree.

Most variable rate bonds are issued by municipal governments.