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    Question

    Floating-rate bonds are designed to minimise which of

    the following risks?
    A Interest rate risk Correct Answer Incorrect Answer
    B Liquidity risk Correct Answer Incorrect Answer
    C Redemption risk Correct Answer Incorrect Answer
    D Default risk Correct Answer Incorrect Answer
    E Systemic risk Correct Answer Incorrect Answer

    Solution

    Floating Rate Bonds (FRBs) are bonds that have a variable coupon, equal to a money market reference rate (like MIBOR or LIBOR) plus a quoted spread (i.e., quoted margin). · Floating rate bonds allow the investor to earn a rate of interest income tied to current interest rates. As such, FRBs carry little interest rate risk. · Its price shows very low sensitivity to changes in market interest rates. When market rates rise, the expected coupons of the FRB increase in line with the increase in forward rates, which means its price remains constant. Thus, FRBs differ from fixed rate bonds, whose prices decline when market rates rise. As FRBs are very less sensitive to interest rate risk, they are considered conservative investments for investors who believe market rates will increase.

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