"A floating-rate note and an extendable reset bond both have coupon rates readjusted periodically. Therefore, they are basically the same instrument." Do you agree with this statement?

What will be an ideal response?

As discussed below, there are differences between a floating-rate note and an extendable reset bond due to the manner in which they are adjusted.

In late 1987, a junk bond came to market with a structure allowing the issuer to reset the coupon rate so that the bond will trade at a predetermined price. The coupon rate may reset annually or even more frequently, or reset only one time over the life of the bond. Generally, the coupon rate at reset time will be the average of rates suggested by two investment banking firms. The new rate will then reflect both the level of interest rates at the reset date, and the credit spread the market wants on the issue at the reset date. This structure is called an extendable reset.

In a floating-rate issue, the coupon rate resets according to a fixed spread over some benchmark, with the spread specified in the indenture. The amount of the spread reflects market conditions at the time the issue is offered. The coupon rate on an extendable reset bond by contrast is reset based on market conditions (as suggested by several investment banking firms) at the time of the reset date. Moreover, the new coupon rate reflects the new level of interest rates and the new spread that investors seek.

The advantage to issuers of extendable reset bonds is again that they can be assured of a
long-term source of funds based on short-term rates. For investors, the advantage of these bonds is that the coupon rate will reset to the market rate—both the level of interest rates and the credit spread, in principle keeping the issue at par.