FRBs Flashcards
What is a floating rate bond (FRB)?
A bond whose coupon payments adjust based on a reference interest rate.
How often are the interest payments reset in a floating rate bond?
Typically quarterly or semiannually, depending on the contract
What is a reset date in a floating rate bond?
The date when the next interest rate is determined based on the reference rate.
What are common reference rates for floating rate bonds?
LIBOR, SOFR, EURIBOR, or the Overnight Indexed Swap (OIS) rate
What is the coupon formula for a floating rate bond?
Coupon = 100 * (Reference rate between two T’s + Spread / period
What happens to the value of a floating rate bond at a reset date?
It equals its face value
How do we price a floating rate bond between reset dates?
Pricefr = Discount rate * 100 * (1 + r / n)
Why does the price of the floating rate bond not fluctuate much between reset dates?
Because the coupon adjusts to current interest rates, reducing interest rate risk.
What is the main risk associated with floating rate bonds?
Interest rate volatility, which affects future coupon payments
Why are floating rate bonds considered lower risk compared to fixed-rate bonds?
Because their payments adjust with interest rates, reducing duration/interest rate risk
What is a duration risk in the context of floating rate bonds?
The bond’s sensitivity to interest changes, whch is typically low for FRBs.
What happens to the price of a floating rate bond when interest rates increase?
It remains close to face value because future coupon payments increase.
What happens if interest rates drop significantly?
Coupon payments decrease, reducing investor returns
How do we calculate the duration of a floating-rate bond?
T- t
Why is the duration of a floating rate bond typically low?
Because cash flows are frequently reset, reducing sensitivity to interest rate changes.
What type of derivative can be used to hedge a floating rate bond?
Interest rate swaps or interest rate caps
How can a borrower protect against rising floating rates?
By purchasing an interest rate cap
How can a lender protect against falling floating rates?
By purchasing an interest rate floor.
Why is LIBOR being replaced as a reference rate?
Due to concerns about manipulation and lack of reliability in the interbank lending market.
What are the preferred alternatives to LIBOR today?
SOFR (Secured Overnight Financing Rate), STR and SONIA
