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Hungary just issued a bond that matures in 2024, pays once a year and has the coupon rate of "1-year treasury bill rate" + 2.5%.

I searched for information on the net how does market sets price on floating rate bonds, and they said the price returns to par after each coupon payment.

Currently the yield difference of the 1 yr and 10 yr bonds is about 2.5%. So it makes sense it's traded on par value. But this spread is constant so as we get closer to the maturity date, I would expect that the price gradually goes up. Imagine the beginning of the last coupon period in 2023: the bond must be traded on premium so the yield of the 1yr bond and the FRN exactly match.

So how does floating rate bond pricing work?

  • Could you provide a link to the information you found on the net? – jjanes Sep 1 '14 at 18:55
  • @jjanes Basically googled for "floating rate bond valuation" and skimmed through several PDFs and websites. For example this one. Chances I didn't read them carefully enough though... – Calmarius Sep 2 '14 at 12:41
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I believe that your analysis is correct, and the floating rate bond price will increase as it nears maturity.

The analysis you point to has the assumption that the floating rate bond has a coupon equal to the market rate. But the bond you discuss has a coupon of the market rate plus 2.5%.

Presumably that premium comes from the market's assessment of the risk of lending to the Hungarian government for 10 years. As the bond nears maturity without incident, there will be less remaining time in which something bad (i.e. a default) can occur. This would justify less of a premium, but since the 2.5% differential is fixed then what will respond instead is the value of the bond.

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