In March 1993, the Student Loan Marketing Association (Sallie Mae) issued five-year notes with a coupon set at 4.5% in the first year and reset quarterly subsequently. The floating quarterly coupon rate was set to be the higher of either 4.125% or 50% of the rate on ten-year Treasury notes plus 1.25%. At time of issue, the interest rates for all maturities were well below 4%, and investors were attracted by the high current yield (4.5%) compared to other straight bonds available.
Assume that in March 1994, interest rates have risen dramatically and that the U.S. Treasury yield curve is now flat at 7% for all maturities.
a. What is the new coupon rate set on the Sallie Mae bond?
b. Why is the Sallie Mae bond now trading at a hefty discount?

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The Answer of In March 1993, the Student Loan Marketing Association (Sallie Mae) issued five-year notes with a coupon set at 4.5% in the first year and reset quarterly subsequently. The floating quarterly coupon rate was set to be the higher of either 4.125% or 50% of the rate on ten-year Treasury notes plus 1.25%. At time of issue, the interest rates for all maturities were well below 4%, and investors were attracted by the high current yield (4.5%) compared to other straight bonds available.
Assume that in March 1994, interest rates have risen dramatically and that the U.S. Treasury yield curve is now flat at 7% for all maturities.
a. What is the new coupon rate set on the Sallie Mae bond?
b. Why is the Sallie Mae bond now trading at a hefty discount?