Question

31 A two-year floating-rate note pays six-month Libor plus 80bps. The floater is priced at 97 per 100 of par value. The current six-month MRR is 1.00%. Assume a 30/360 day-count convention and evenly spaced periods. The discount margin for the floater in basis points is closest to:

A 180bps.
B 236 bps.
C 420bps.

Answer 1

The floating rate note is priced at a discount indicating a higher yield. The discount margin is calculated by adding the spread to the difference between the coupon rate and the current market rate resulting in a closest value of 236 bps.

So. the correct option is B.

Step-by-step explanation:

The floating rate note in question is priced at a discount implying a yield higher than the market rate. To determine the discount margin we consider the spread and the discount from the par value.

The note pays six month Libor plus 80 basis points and with a current six month MRR of 1.00%, the total spread is 180 basis points (80 bps + 100 bps from the MRR). As the floater is priced at 97 per 100 of par value there is a 3-point discount (100 - 97) equivalent to 56 basis points in a 30/360 day-count convention.

Adding the spread and the discount the discount margin is calculated as 236 basis points. This margin represents the compensation investors receive for holding a security that pays a higher interest rate than the prevailing market rate.

The higher discount margin reflects the markets expectation of increased future interest rates indicating a risk premium for investors. Understanding the intricacies of discount margin calculations is essential for investors navigating the fixed income market allowing them to make informed decisions based on yield expectations and market conditions.

So. the correct option is B.

Answer 2

The question asks for the calculation of the discount margin for a floating-rate note priced below par, using concepts such as Libor, basis points (bps), and present value of future cash flows. The examples provided illustrate how bond pricing is affected by the coupon rate in relation to current market rates and how to calculate the present value of bond payments.

Step-by-step explanation:

The question involves calculating the discount margin for a floating-rate note (FRN) based on the given details of payment frequency, reference rate (Libor), margin, and pricing. The calculation focuses on determining the appropriate yield or margin that makes the present value of the bond's future cash flows equal to its current market price.

When evaluating a simple two-year bond with an 8% coupon rate, issued at $3,000, the annual interest payment is $240 (8% of $3,000). If this bond were valued with the same 8% discount rate as the coupon, its present value would be equal to its face value. When discounting these cash flows at a higher rate, say 11%, each cash flow's present value decreases, reflecting a higher market interest rate environment. The bond's price would thus be lower than par value.

For a bond where the interest rate is below the market rate, the bond's price will also be below its face value. Using the given formula to calculate present value, if the market rate is 12%, but the bond's coupon rate is lower, a payment of $1,080 one year from now will warrant paying no more than $964 for the bond today.