CFA Practice Question

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CFA Practice Question

A five-year variable rate note specifies a cap of 9.5 % for the life of the contract and a margin of 0.0075. On the coupon reset date, the reference rate is 10.25%.

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: C

The rate cap on this note prevents the coupon from adjusting to 11%.

User Contributed Comments 8

User Comment
hrai1 Where does the 11% come from?
db28luke 10.25% + 0.75% = 11%
danlan Rate=margin + reference rate=11% > 9.5%, so the price is less than par.
eb2568 So I think that means that if it priced at 11% w/o the cap it would be at par, but b/c its priced at 9.5% it is below par?
Laurier "...but this one goes to 11..."
johntan1979 coupon < market ==> sell at a discount (less than par)
gill15 What if we are already at the CAP and then the reference rate increases again. Would it make any difference to the price of the Floatin rate security? I would say no...anybody?
HolzGe1 gill: yes it would make a difference. The discount offsets the required, but unpaid rate, so the discount must be even deeper in your case.

What price would you pay for a FRN capped at 0.5% when the reference rate was at 15%? Not a lot, I hope!
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