Mai
Nguyen
Dawn of Finance
8
o
Advantage: bonds with a sinking fund provision have less credit risk because the periodic
redemptions reduce the total amount of principal to be repaid at maturity.
o
Disadvantage to bondholders when interest rates fall.
A bondholder would suffer a loss if her bonds were selected to be redeemed at a price below the
current market price.
the bonds have more reinvestment risk because bondholders who have
their bonds redeemed can
only reinvest the funds at the new, lower yield
b) Not – fixed coupon structure
b.1) Floating – Rate Note (FRN)/ Floater
pay periodic interest that depends on a
current market rate of interest –
reference rate
promises to pay the
reference rate plus some interest margin – typically expressed in
basis points
𝒄𝒐𝒖𝒑𝒐𝒏 𝒓𝒂𝒕𝒆 = 𝒓𝒆𝒇 𝒓𝒂𝒕𝒆 (𝒏𝒐𝒕 𝒇𝒊𝒙𝒆𝒅) + 𝒃𝒂𝒔𝒊𝒔 𝒑𝒐𝒊𝒏𝒕𝒔 (𝒇𝒊𝒙𝒆𝒅)
Eg: a floating-rate note that pays the London Interbank Offer Rate (Libor) plus a margin of 0.75%
(75 basis points) annually.
The new l-year rate at the end of one year will determine the rate of interest paid at the end of the
next year.
Eg: Coupon rate
2020
=
Ref rate
2019
+ Basis points
Most floaters pay quarterly and are based on a quarterly (90-day) reference rate.
A floating-rate
note may have
o a
cap benefits the issuer by placing a limit on how high the coupon rate can rise
o a
floor benefits the bondholder by placing a
minimum on the coupon rate
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