A 3-year floating-rate note (FRN) pays the Secured Overnight Financing Rate (SOFR) + 80 basis points (bps). Six months in, credit deteriorates and the market demands SOFR + 120 bps. The coupon is unchanged. Where does price go, and how do you size the discount?
A floating-rate note resets its coupon each period using a market reference rate (MRR) such as SOFR, plus a credit spread set at issuance called the quoted margin (QM). The QM compensates investors for the issuer's credit risk relative to the reference benchmark. Once issued, QM is locked.
The market's view of fair credit compensation can drift. The spread investors require today is the required margin, also called the discount margin (DM). DM is the floating-rate analogue of yield to maturity (YTM). It is the spread over the MRR that makes the discounted cash flows equal the current price. You calculate it from the price, then interpret the yield spread by comparing it with QM.
Common mistakes
- Assuming an FRN has no reference-rate risk. Resets cut this risk but do not remove it. Between resets the next coupon is already fixed. Even on a reset date, the reference rate changes the size of a premium or discount when DM differs from QM.
- Discounting at the reference rate alone. The discount rate is MRR + DM, not MRR. Omitting a positive DM understates the discount rate and overstates the price. Trap: in Example 1, discounting at SOFR alone gives $1,008.63 instead of $995.01.
- Stopping before you subtract the MRR. In Example 2 the calculator returns a quarterly 1.1817%, which annualizes to 4.7270% using full precision. Trap: reporting 118 bps (the quarterly rate) or 473 bps (MRR + DM) instead of the 173 bp discount margin.
Bottom line
- FRN coupon = reference rate + quoted margin (QM), reset each period; the quoted margin is fixed at issuance.
- Required margin (discount margin, DM) is the spread the market demands now. DM versus QM sets the price direction; resets reduce reference-rate risk but do not eliminate it.
- DM = QM → par; DM > QM → discount; DM < QM → premium.
- To solve DM from price: find the periodic yield, multiply by m, subtract the MRR. Subtracting a negative MRR adds its magnitude.
Exam shortcut
For FRN pricing direction, remember "DM beats QM, price retreats" (DM > QM = discount). To solve for DM, set P/Y = C/Y = 1 and END mode, then use the time-value-of-money (TVM) keys: N = periods left, PV = −price, PMT = (MRR + QM) / m × face, FV = face. CPT I/Y, multiply by m and subtract the MRR.
The full lesson (about 3,036 words, 20 min read) adds 4 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- yield measures floating-rate instruments
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