Pricing Floating-Rate Debt and Related Interest Rate Options

February 1, 1990

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

Most developing country debt is denominated in U.S. dollars and has a floating interest rate. The pricing of floating rate debt and related interest rate options are examined in this paper. Formulas for pricing ceilings and floors on floating rate debt are derived for several different models of interest rate variability. A framework for pricing risky debt and loan guarantees is presented, and the implications of the debtor country’s default option are analyzed. The elimination of large principal repayments, by collateralizing the principal, serves to reduce the debtor country’s incentive to use its default option.

Subject: Bonds, Debt default, External debt, Financial institutions, Loans, Options, Securities

Keywords: Bonds, Debt default, defaultable debt, discount bond, interest rate, interest rate movement, Loans, Options, rate debt, rate loan, Securities, T-bill rate, value of the floor, WP

Pages:
22
Volume:
1990
DOI:
https://doi.org/10.5089/9781451842333.001
Issue:
007
Series:
Working Paper No. 1990/007
Stock No:
WPIEA0071990
ISBN:
9781451842333
ISSN:
1018-5941

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