Callable FRN
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Callable Floating Coupon Note Valuation
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| 1. Callable Floating Coupon Note Valuation |
A floating coupon note is a very flexible and generic funding product. The issuer pays the buyer periodic floating coupons based on a spread-adjusted reference rate, such as LIBOR. The buyer pays an upfront fee to the issuer. Also, the buyer pays the issuer a notional amount at inception and the issuer returns it upon cancellation or maturity of the deal.
At each payment date, the payoff could be straight, call, put, digital call, or digital put style function (very flexible according to contract) based on a relative return on a given notional or absolute difference between fixing rate and strike. A floor and weight may be applied.
A callable floating coupon note gives the issuer to recall the note on specified future recall dates at a predetermined recall price. The callable future is known upfront and allows the issuer to cancel the note and pay off the notional before maturity.
Callable floating coupon note usually pay a higher coupon or interest rate to investor. Institutions may issue callable floating coupon notes to fund expansion or to pay off loans. This type of note is in demand among investors when interest rates are low and expected to rise.
| 2. Related Topics |
| 2.1. Fixed Rate Bond |
A fixed rate bond pays coupons at a fixed rate over the bond life. An investor who wants to earn a guaranteed interest rate for a specified term can choose fixed rate bonds. Due to the fixed coupon, the market value of a fixed rate bond is susceptible to fluctuation in interest rate and therefore has a significant interest rate risk.
The present value of a fixed rate bond can be expressed as
You can find more details at Bond Valuation
| 2.2. Zero Coupon Bond |
A zero coupon bond is a bond that doesn’t pay interest/coupon and instead pays one lump sum face value at maturity. Investors buy zero coupon bonds at a deep discount from their face value. Zero coupon bonds are probably the simplest bond type in the market.
The present value of a zero coupon bond is given by
You can find more details at Zero Coupon Bonds
| 2.3. Amortizing Bond or Accreting Bond |
An amortizing bond is a bond whose principal (face value) decreases due to repaying part of the principal along with the coupon payments, while an accreting bond is a bond whose principal increases during the life of the deal. The analytics are similar to a fixed rate bond except the principal amount used for each period may be different.
The present value of an amortizing bond or accreting bond is given by
Practical notes
- All practical notes for pricing floating rate notes are applicable to amortizing bond or accreting bonds.
- You need to determine notional principal amount for each cash flow when you generate it.
You can find more details at Amortizing Bond or Accreting Bonds
| 3. Related Topics |