CFA Practice Question

There are 490 practice questions for this study session.

CFA Practice Question

Which of the following statements is (are) valid regarding the interest rate risk for floating rate securities?

The price of a floating-rate security will fluctuate because ______.

I. the longer the time to the next coupon reset date, the greater the potential price fluctuation.
II. the required margin that investors demand in the market changes.
III. a floating-rate security can have a cap.
A. I and II
B. I and III
C. I, II and III
Explanation: With respect to the interest rate risk for floating rate securities, the price of a floating-rate security will fluctuate because:
  • The longer the time to the next coupon reset date, the greater the potential price fluctuation.
  • The required margin that investors demand in the market changes.
  • A floating-rate security can have a cap.

User Contributed Comments 8

User Comment
Shadefx wouldnt a cap prevent fluctuation?
CocaColas A cap implies that the bond's price would fluctuate in response to an interest differential between the coupon rate (now capped) and the prevalent interest rate, which might be higher..
Kashi2010 The assertation that a FRN would 'typically have a cap' is incorrect - I work in corporate bond issuance (GMTN & 144a) and we issue a large number of FRN bonds, none of which have ever included a cap provision in the indenture.
DanHuk If the required margin changes, that is investors demand i.e. a higher spread over LIBOR in the secondary market, wouldn't that be an issue of credit rather than interest rate risk?
charlie that's what the textbook says, DanHuk.It is because the floating rate is reset based on a reference rate plus a fixed quoted margin.
AllieBarrell The cap would not be a reason for the fluctuation though?.... I see, this is the cap risk.
Tboyalone i think wat they re tryin to say is risks associated to interest rates flunctuation....uhn!?
mrpman if the bond/note is fixed then when market yields rise (YTM) your coupon stays the same, hence the difference between market and par value, but a floating rate security will have a YTM that is equal to par b/c the coupon keeps moving (variable). This means that there is no fluctuation, but when you add a cap to the bond you esentially converted it from a variable rate to fixed rate (only if the YTM jumps above the cap rate)
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