# Variable rate debt and Market value

Hello folks, Can anyone explain following statement: Variable rate debt reset interest rate peridically and has the effect of keeping the market value of debt close to its par value If rate increases, how can it still can have value close to its par value(original value) ? -Thanks

Hello With variable rate why balance sheet value and market value does not change with market rates ? -Thanks,

So I have a variable rate bond and its interest rate resets every 6-months. It’s currently paying 6 month LIBOR + 100 bp from the last reset 4 months ago. Suddenly, the recession is over! 6-month interest rates jump 3% in 5 minutes. How much have I lost?

Isn’t that mean Market value changes with variable rate. I am still trying to understand the logic. Help will be appericiated.

The market rate of the bond changes but since it’s only got two months to reset all taht’s happening is that I have a two-month duration bond. The way to think about it is that at every reset from an interest rate perspective, I have a brand-new bond. That means that I might have an 8-yr bond but the interest rate move is going to affect it like it’s a two-month bond.

Are we saying that for variable-rate, book value listed on balance sheet keeps changing, based on the chang of market rate(variable rate) ?

Check this example on FASB: http://www.fasb.org/derivatives/examples.pdf

if coupon = interest rate -> bond trades at par since coupon is reset to be equal to the interest rate, bond trades close to par

cfa20089 Wrote: ------------------------------------------------------- > Are we saying that for variable-rate, book value > listed on balance sheet keeps changing, > based on the chang of market rate(variable rate) ? I’m saying that the market value changes but only slightly. How it’s accounted for on the balance sheet depends on those “accounting for bonds” issues.

Any changes in the market value of the bond - will never get reflected on the Balance sheet of the corporation, until it is sold. The Balance Sheet always keeps the historical information. However, there are other adjustments – unrealized gain/loss etc. components that would show up on the Statement of Comprehensive Income – which will reflect the difference between the market value of the debt instrument and what you purchased it at.

Isn’t there a bunch of stuff about “trading securities” vs “available for sale” vs “held to maturity” and the balance sheet reflects different values for the bond depending on which category it belongs to? That was the case many moons ago when I last cared about that…

All that is L2 material, I believe JDV. When I did L1 (many moons ago, last year), the only thing we were required to know with respect to that was is there an unrealized gain / loss when rate rises, rate falls. Not sure about 2008 CFA Curriculum and LOS – what is required as per that. CP

Held-to-maturity: debt securities that the management intends to hold until maturity, reported at amortized cost I/S: Interest earned +/- Realized gains/losses, (realized gains or losses calculated as Sell price less Carrying value) B/S: Amortized Cost Available-for-Sale: debt or equity (equity that is not expected to trade on a short-term basis, or debt not expected to be held until maturity), reported at fair value I/S: Dividends (if stock) or interest earned (if bond) +/- Realized Gains/losses B/S: Fair Value with Unrealized Gains/Losses treated as a direct-to-equity adjustment (unrealized gains/losses calculated as Ending value less Beginning value) Trading Securities: debt or equity actively traded on a short term basis, reported at fair (market) value I/S: Dividends or interest earned +/- Realized Gains/Losses +/- Unrealized Gains/Losses B/S: Fair (market) value

There are also (I have to memorize this one of these days!): Receivables (payables) and loans: reported at fair value when assets, amortized cost when liability Unlisted instruments with no readily available fair values: reported at amortized cost, when either asset or liability Derivatives (stand-alone or imbedded in nonderivative instruments): reported at fair value, when either asset or liability Nonderivative instruments with fair value exposure hedged by derivatives: reported at fair value, when either asset or liability All other financing liabilities, reported at amortized cost.