Why do floating rate notes still have price risk even though the coupon resets?

Floating rate notes (FRNs) have coupons that reset periodically to a reference rate (e.g., SOFR) plus a fixed spread. While this eliminates most interest rate risk, it does not eliminate all price risk.

Sources of Price Deviation from Par:

1. Credit Spread Changes: The fixed spread set at issuance may differ from the market's current required spread. If credit conditions worsen, the market demands a wider spread than the FRN pays.

1. Between-Reset Pricing: Between coupon reset dates, the coupon is fixed. If rates move during this period, the FRN has some duration exposure.

1. Credit Risk: If the issuer's creditworthiness deteriorates, the FRN's price falls even though the coupon resets.

Example — Oakridge Financial FRN (fictional):

Issued at par with coupon = SOFR + 150 bps. Six months later:

Pricing the Spread Change:

If the required spread widens by 100 bps and the FRN has 3 years remaining:

• Approximate price change = -Duration x Spread change
• With modified duration of ~0.25 (to next reset) for rate risk, but ~2.8 for credit spread risk
• Credit-driven price change ≈ -2.8 x 1.00% = -2.8% (price drops to ~$97.20)

Key Distinction:

• Interest rate duration is very low (resets to next coupon date, typically 0.125-0.25 years)
• Credit spread duration equals the bond's remaining maturity, because the fixed spread component does not change

This means FRNs protect against parallel rate shifts but not against credit spread widening.

Exam Tip: The CFA exam distinguishes between interest rate risk and credit spread risk for FRNs. An FRN's effective duration for rate changes is near zero at reset, but its spread duration equals time to maturity.

Explore FRN pricing in our CFA Level I question bank.