Why does a floating rate note (FRN) always trade at par on its coupon reset date?

This is a classic fixed income concept that confuses many candidates. Let's break it down carefully.

The Key Insight: At Reset, the Coupon Matches the Discount Rate

A floating rate note pays a coupon equal to a reference rate (say SOFR) plus a fixed spread (the quoted margin). On each reset date, the coupon resets to the current reference rate plus the quoted margin.

If the bond's credit risk hasn't changed since issuance — meaning the quoted margin still reflects fair compensation for the issuer's credit risk — then at the reset date:

• Next period's coupon = Current market rate + Spread
• Discount rate = Current market rate + Spread
• Since coupon rate = discount rate, the bond prices at par

Step-by-Step Pricing on a Reset Date

Consider a quarterly-reset FRN issued by Meridian Logistics with a quoted margin of 80 bps over SOFR. SOFR is currently 4.50%.

At the reset date:

• Next coupon = (4.50% + 0.80%) / 4 = $13.25 per $1,000 face
• After receiving that coupon, the FRN resets again at the next SOFR rate
• At that next reset, the same logic applies — coupon = discount rate, so the bond is worth par
• Working backward: PV of ($1,000 + $13.25) discounted at (5.30%/4) = $1,000

This recursive logic means on every reset date, the FRN is worth par (assuming no credit change).

Between Reset Dates — FRN Trades Away from Par

Between resets, the coupon is fixed (set at the last reset), but market rates may have moved. During this interim period, the FRN behaves like a short-term fixed-rate bond and its price deviates from par. However, this deviation is small because the time to next reset is short (usually 90 days).

When Does an FRN NOT Trade at Par on Reset?

1. Credit migration: If Meridian Logistics is downgraded, the market demands a higher spread than the quoted 80 bps. The FRN trades below par.
2. Discount margin vs quoted margin: If the market-required spread (discount margin) exceeds the quoted margin, the FRN trades at a discount even at reset.

Formula:

If discount margin > quoted margin: FRN price < par at reset

If discount margin = quoted margin: FRN price = par at reset

If discount margin < quoted margin: FRN price > par at reset

Exam Tip: CFA Level I questions may present an FRN where the issuer's credit quality changed and ask you to determine whether the FRN trades above, at, or below par. Compare the discount margin to the quoted margin.

Check out our CFA Fixed Income practice questions for more FRN scenarios.