Discount Margin for a Floating Rate Note

CFA Level I Fixed Income
#1

Some of my students have had issues with Practice Problem 31 from the reading on Fixed Income Valuation. You are given LIBOR, the current price and the quoted margin. Your job is to compute the discount margin.

Unfortunately the curriculum’s explanation is very long winded and hard to understand. I’ll give you a short and easy method of solving such problems… But first try this question:

You are evaluating a 3 year floating rate note which pays 6 month KIBOR plus 200 bps. This security is priced at 95 per 100 par. Current 6 month KIBOR is 10%. Assume a 30/360 day-count convention and evenly spaced periods. What is the discount margin?You are evaluating a 3 year floating rate note which pays 6 month KIBOR plus 200 bps. This security is priced at 95 per 100 par. Current 6 month KIBOR is 10%. Assume a 30/360 day-count convention and evenly spaced periods. What is the discount margin?

I’ll post the solution in the next couple of days.

Regards,

Arif Irfanullah

#2

With this problem here is the process you can can follow:

  1. Draw the timeline

  2. Recongnize that the cash flow is $6 every period for 6 periods plus 100 par at the end.

  3. Use the calculator to compute the rate such that PV = 95

  4. From the rate compute the discount margin.

This video explains the process:

[video:https://docs.google.com/file/d/0B8JxctcuSgRDNUsySzZiZ1Y0cHM/edit]

#3

is the DM 2.1012%?

#4

4,1% on s.a. basis. 2.05% for every period.

I remember this typeof question from the FI review.

My problem with this question is that when first looking at it I didn’t know what yield I should calculate?

Bank discount yield? Bond equivalent yield? And though I (think I) know the definition for all yields and how to calculate them I totally got confused (and still am) on all the yields.

So my question is: is there a way to get a clear understanding on all the yield types and if yes in which study session?

Because Quants (Reading 2/6) and FI (15/54) made me confused.

(If I’m the only person like this than good news to you all - I’m not your competitor for the exam)