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Suppose we have disregard the losses in an FRN mutual fund due to credit events. Which are the most harmful scenarios to its value? Lower or higher rates?

Bond funds gain in value if rates fall and lose if rates rise, but these kind of bonds get higher principal if short rate moves up.

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these kind of bonds gets higher principal if short rate moves up.

True, but the rate is still fixed for a period of time (until the next reset date), so they do lose value in the short term if interest rates rise. So a rise in interest rates would still lower the value of an FRN fund but not nearly as much as a fund of fixed-rate bonds.

  • What if the longer term rates rises? that should also lower the value. Since the "baseline" gets a lower value right? – user1 Jan 14 at 5:35
  • No, because the bond will be priced as if the long-term coupons are paid at the higher rate. – D Stanley Jan 14 at 13:20
  • But then there will be new FRN issued with higher base interest which will be worth more right? i.e the old once loose value? – user1 Jan 14 at 13:22
  • Floaters pay interest at a spread over some base rate, say LIBOR plus 50 bps. So if LIBOR changes, it will change for both notes equally. – D Stanley Jan 14 at 13:25
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    No worries - this stuff can be tough to digest. Higher interest rates do not mean higher spreads.The spread is more indicative of the credit risk. So when valuing a bond you compare it to bonds of similar credit risk (and hence similar spreads). – D Stanley Jan 14 at 14:42

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