(1) If the credit worthiness of the issuer of a 4-year Floating-Rate Note changes drastically in the 2nd year, should not the spread component of the FRN coupon rate (which is fixed at issuance) also be increased along with the yield on the note at that point in time?
(2) If yes, based on what scale should the coupon be increased? If not, does the increase in the spread component only occur when the issue is bought by another note-holder after the conclusion of the term with the current note-holder?
No. The spread in the coupon is established in the bond indenture and is generally fixed. That is to say, I’ve never known one that wasn’t fixed.
If the credit quality of the issuer or the issue declines, the price simply will reset to something below par at each coupon date, because the discount rate will be higher than the coupon rate.
Thanks for the clarification. So the coupon rate does not change but the yield does. And I guess the coupon rate’s spread component can be renegotiated with the current note-holder if s/he wishes to renew his/her hold (assuming the issuer’s credit quality is still in a bad state).