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Pricing FRNs

Suppose an issuer comes to market with a 5 year, quarterly reset FRN that pays LIBOR + 100 bps for a coupon. It prices at par. 1 year later, suppose credit spreads have materially backed up and a fair discount margin for this FRN is now 200 bps. How do you price this? My confusion is that there is a fixed and a floating portion of this coupon. I.e, the FRN only protects you from changes in LIBOR, not changes in the underlying issuer’s spread movement. 

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You need to dissect the note into two parts: 1) A zero coupon bond with credit of the issue, representing the principal you receive at maturity, and 2) A swap where you receive libor+100bp, representing the coupon.

In terms of pricing, 1) discount the zero coupon bond using the issuer’s credit. So if the credit spread widens, NPV will decrease. 2) model the swap as a stream of libor+100bp payments DISCOUNTED using the issuer’s credit. So, the swap stream involves two rates curves: a normal libor curve, used to determine the future value of coupons, and a credit adjusted curve, only used to discount the coupons.

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Is there a minimum for these in terms of notional values?