The term variable-income security refers to investments that provide their owners with a rate of return that is dynamic and determined by market forces. Variable-income securities provide investors with both greater risks as well as rewards.
Variable-income securities, also known as variable-rate securities, are typically valued by investors looking for higher returns than those offered by fixed-income securities. The classic example of a variable-income security is common stock, which can offer investors virtually unlimited up-side growth as well as the complete loss of principal. In exchange for this risk, investors in these securities demand higher returns than their fixed-income counterparts. In addition to common stocks, examples of variable-income securities include:
- Variable Rate Demand Obligations (VRDO): municipal bonds that have long-term maturities that reset on a relatively short-term basis.
- Floating Rate Notes (FRN): bonds that feature a variable rate coupon, typically indexed to a money market rate such as federal funds or LIBOR plus a margin spread. The rate of interest on FRNs will increase or decrease quarterly based on the auction rates of 13-week Treasury bills.