Floored and Capped Bonds

Question 15 CFAI
"Bond #7 One-year Libor annually, set in arrears, capped at 5.00%. The value of Bond #7 is closest to?

Why is the coupon rate for such questions considered to be the previous year’s 1year forward rate?


These three words mean that “The coupon rate is set one year in advance, and paid at the end of the year”. So the coupon rate for Year 2 is already determined in Year 1 (based on the 1-year LIBOR for an annually-paid coupon, which is the 1-year forward rate in Year 1), but will only be paid in Year 2.

Actually, they don’t.

The author goofed there.

“Set in arrears” properly should mean that the coupon rate is set at the end of the period; i.e., on the date that the coupon payment is made. That would be weird, but that’s what it would mean.

What the author meant to say is that the coupon is set in advance and paid in arrears.

I e-mailed CFA Institute about this error quite a while ago and they acknowledged that it’s an error. I don’t know whether they’ve corrected it (or issued an erratum), but they should have.

Oh you’re right there. My mind processed it as “Set in advance, paid in arrears”. I goofed up too. :dizzy_face: