CFA Practice Question

CFA Practice Question

Which of the following is most likely correct?
A. An inverse floater is a bond (or other debt) whose principal rises when Treasury Bill prices fall.
B. Two floaters are identical in all respects, except one has a cap and the other does not. The duration of the one with a cap will be higher than the one without the cap.
C. Two floaters are identical in all respects, except one has a cap and the other does not. The price of the one with a cap will be greater than the one without the cap.
Explanation: An inverse floater is a bond (or other debt) whose coupon payments fall when Treasury Bill prices fall (that is, short term rates rise).

A floater cap benefits the issuer, so the price of a floater with a cap will be lower.

The price sensitivity of a floater is higher than the price sensitivity of an ordinary bond (as the floating coupon exacerbates the change in interest rates), which means the duration is higher.

However the cap reduces the impact of the floater, so the duration is higher than without the cap.

User Contributed Comments 1

User Comment
cwest020 A larger coupon will always decrease duration. If rates go to 20% and one has a cap of 10% and the other floats and pays a 20% coupon, there will be less price fluctuations in the bond without the cap.
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