Floating-Rate Note Yields

CFA Level I Fixed Income
#1

Hi all,

the Schweser mention on page 49 (chapter Floating-Rate Note Yields) the following implication:

If the credit quality of the issuer decreases, the quoted margin will be less than the required margin and the FRN will sell at a discount to its par value.

Sorry, but I don’t get these conclusions.
If the credit quality decreases, the credit risk increases. Therefore, the issuer must offer a higher spreas.
As the floating rate consists of MRR + margin (constant) this adjustment can’t be done.

So why does a decrease in credit quality / increase in credit risk imply the quoted margin to be less than the required margin?

Additionally, if the quoted margin is less than the required margin, why does the bond sell at a discount?
The required margin is the one “needed” to return the FRN to its par value.
So I discount the bond by the required margin to get the market value?
And therefore: higher required rate → lower value

Hopefully someone may help me.

Cheers

#2

Suppose that the note pays LIBOR + 100bps and sells at par.

Next week the credit quality decreases, so the market decides that they should be paying LIBOR + 200bps. The note is still paying LIBOR + 100bps (that’s not going to change; it’s set in the indenture), so:

  • The spread it pays (100bps) is less than the spread that the market requires (200bps), and
  • The note will sell at a discount.
1 Like
#3

Thank you… so just some definitions:

the quoted margin is the one set in the indenture → and therefore constant
the required margin is just a theoretical one (?) as it is not stated in the indenture and will not be paid

Overall, there is no change in the quoted margin, the change takes place in the expectations about the required margin?

Sorry one other question:
Whats the yield in this example? It is mentioned that “if the yield goes up, the price will decrease”.
I understand that the price decreases if the discount rate increases, but how do I bring the words yield and discount rate together?

If I use a higher discount rate for the CFs, the PV will decrease. But the yield should be something similar to the coupon rate? so if the coupon rate increases, the PMT increases?
Or does yield refer to the “discount rate” / market return?