Which statement best describes a floating rate loan?

• A. The rate moves with general interest rates and reflects borrower default risk.
• B. The rate is fixed for the life of the loan.
• C. The rate never changes after origination.
• D. The rate is determined only by the loan's term length.

Answer: (A)

Floating rate loans adjust their interest based on a benchmark that moves with overall market rates, plus a spread that reflects the borrower’s credit risk. This means the borrower’s interest payments rise or fall as general rates change, while the lender is compensated for the borrower’s default risk through that spread. That combination—a rate tied to a changing reference rate and a credit-related margin—is what characterizes a floating rate loan.

This differs from a fixed-rate loan, where the rate is locked for the life of the loan and doesn’t respond to shifts in market rates. So the statement that the rate moves with general interest rates and reflects borrower default risk best describes a floating rate loan.