Pricing Floating-Rate Debt and Related Interest Rate Options
February 1, 1990
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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:
Issue:
007
Series:
Working Paper No. 1990/007
Stock No:
WPIEA0071990
ISBN:
9781451842333
ISSN:
1018-5941
