- CFA Exams
- CFA Level I Exam
- Topic 6. Fixed Income
- Learning Module 8. Yield and Yield Spread Measures for Floating-Rate Instruments
- Subject 1. Yield and Yield Spread Measures for Floating-Rate Notes
CFA Practice Question
A seven-year variable rate note issued by a Baa-rated issuer resets its coupon rate to six-month LIBOR + .0075. At issuance, the terms of the contract determined that the issue would be priced at par. Three years after issue, credit conditions have changed and credit spreads have narrowed (i.e., the credit premiums charged lower credit quality borrowers are lower than during previous market conditions). In this new market environment ______
B. the price of the variable rate note will equal par.
C. the price of the variable rate note will be less than par.
A. the price of the variable rate note will be greater than par.
B. the price of the variable rate note will equal par.
C. the price of the variable rate note will be less than par.
Correct Answer: A
The margin compensates the note owner for the credit risk associated with the issuer. If this credit risk now requires a smaller premium, the fixed margin will increase the value of the note.
User Contributed Comments 8
| User | Comment |
|---|---|
| achu | The MARGIN compensates the note owner for the CREDIT risk associated with the issuer. Thus, this 'old' note with higher credit spread is worth more than its initial par. |
| azramirza | narrow spreads? |
| 2014 | Narrow spread means low risk premium less default risk wider spread means high risk premium higher default risk. Margin compensates with wider spread (Higher risk premium as high default risk) Now, default is no more as this question says narrow spread. The issuer is paying more. Since, margin is fixed. So value increased. |
| johntan1979 | Thanks 2014! |
| ldfrench | Last two have been great questions |
| praj24 | Thanks 2014 |
| dbedford | They all float down here... |
| walterli | credit risk is higher,so price raised |