AuthorTopic: floater
wexwarez
@2005-05-17 04:21:54
A two-year floater is paying a coupon of six-month LIBOR + 2%. Assuming a discount margin of 1% and that LIBOR is currently 6%. What is the most likely price of the floater?
A $ 98.31
B $100.00
C $101.84
D $103.72
katentim
@2005-05-17 19:35:51
if this question comes out in exam, I would have spent 5 mins and not knowing whether I got it right.

N = 2yrsX2 = 4 (six-mth)

FV = 100 (usually you use 1000 depending on the answers provided. In this case, use 100)

coupon pymt = 6% + 2% = 8%;
bcos it is six-mth, 8/2 = 4%.
Therefore, 4% of 100 = $4

I/Y = 8% - 1%(discount margin) = 7%
therefore, I/Y = 7/2 = 3.5%

Use your calculator and find PV. Answer is C.

Frankly speaking, I m still blur after attempting this question. I also don't know what is discount margin. I m just trying to make sense to find the answer. What's the answer wexwarez?
wexwarez
@2005-05-18 18:54:58
Hi no background, well done you got it!

Floating rate securities are also known as variable rate securities or floaters. The coupon paid over the life of the note fluctuates by reference to an agreed formula. The coupon is typically based on a "reference rate + margin".

Discount margin = IRR - Reference rate

Hence IRR = Reference Rate + Discount Margin

IRR = (6 + 1) = 7%

Semi-annual discount rate = 1/2 x IRR = 1/2 x 7 = 3.5%

Then discount (as no background did) to find PV

= Answer(C)

It is straight forward if you know what the reference rate and discount margin are; if you know neither of them it is impossible how ever much time you spend on it!

In this case you also have to recognise (although it tells you) that it will be semi-annual discounting.
MGM13
@2005-05-18 21:26:14
I am not familiar w/ the specific term "discount margin" and have never seen it. So that threw me off for a second. It is usually posed at the yield on the bond, and if so, they may not tell you if it's an annual yield (usually assumed to be this) or semi-annual (or whatever frequency the interest payments are). If it's annual and the payments are semi, you'd need to take the square root of 1+ annual yield to get the true semi-annual yield. Cutting it in half gets you close, but not precise enough if two of the answer choices for the bond's PV are close to each other (not uncommon).

For the question you indicated here, using the true semi-annual yield (3.4408%) as "i" in your HP, you should get a bond price of 102.06.

Basically, though, you're on the right track.

CFA Discussion Topic: floater

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