As ques is asking The variability of the coupon rate on a Libor-based floating-rate bond, so change in Coupon Rate due to change in spread as if credit rating changes so spread will be widen or narrow and we should add the spread in the LIBOR. And accordingly it changes. But as per solution the ans is A. Pls explain
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CR= LIBOR + SPREAD
Here, LIBOR keeps on changing but the spread is fixed. CR= LIBOR on every reset date. Ofcourse, spread can change on account of credit worthiness of the company but generally as a rule only the LIBOR changes on every reset date and the SPREAD remains fixed unless there is a change in the creditworthiness of the company. In the question, nothing about the creditworthiness is mentioned so we have to assume that SPREAD has not changed.
If you go through the options than in option 2 its mentioned, so here I got confused with respect that if credit worthiness changes than definitely spread will change
Yes its mentioned in the option but then the question doesn’t say anything related to it. So we have to assume that the spread is fixed.
So, since the question says that it is a FLOATING RATE BOND, it means that the spread is FIXED, only the reference rate will change for the coupon amount.
Option B and C refers to changes in spread, but since the spread is fixed, it won’t bring about any volatility in the COUPON. The discount rate can change though, causing a price fluctuation, but coupon won’t be affected.
Coupon will only be affected by change in the reference rate. Hence option A is the answer.
Hope this helps!