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CFA Level I · CFA Level I Exam · Yield and Yield Spread Measures for Floating-Rate Instruments

A floating-rate note (FRN) pays a coupon equal to the reference rate plus a quoted margin. The required margin is the spread the market demands over the reference rate to price the FRN at par on a reset date. If the issuer's credit quality deteriorates after the last reset, the FRN's price on the next day is most likely:

The FRN would most likely trade below par. Credit deterioration raises the required margin above the fixed quoted margin, so the coupon is too low for the risk and the discounted value of the cash flows falls under par, even though the reference rate is unchanged.

  1. Aabove par because the coupon is floating
  2. Bbelow par because the quoted margin is now less than the required marginCorrect
  3. Cequal to par because the reference rate has not changed

Explanation

An FRN prices at par when the quoted margin equals the required margin. Credit deterioration raises the required margin while the quoted margin is fixed, so cash flows are discounted at a higher rate and the price falls below par. Floating coupons remove reference-rate risk but not credit-spread risk.

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