I do not understand these two terms. The textbook describes them as:
Quoted margin: A specified spread that is added to or subtracted from the market reference rate.
Required margin (Discount margin): The yield spread over or under the reference rate such that the floating rate note (FRN) is priced at par value on a rate reset date. The required margin is determined by “the market” (??? huh?)
What does it mean by “the market?” Nothing has ever been so ambiguous in my life. What do they mean by this? Who sets the damn rate???
The book then goes on to describe the following relationship:
If Quoted margin > Required margin, then the FRN will trade at a premium.
If Quoted margin < Required margin, then the FRN will trade at a discount.
I fundamentally do not understand these relationships. If the spread that is added to the market reference rate is (in absolute terms (bps)) is greater than the yield spread that is required by “the market,” the FRN will trade at a premium and PV > 100. So, is this saying that because MRR + Spread > Spread that the market wants, the FRN is more valuable?
Also, is “Required margin” the same thing as yield to maturity? The book outlines the following relationship:
YTM = MDR = Required Yield = Internal Rate of Return (IRR)
Is the required margin (discount margin) the same thing as YTM in this instance?
Also, can someone please tell me what the Wall Street Journal has to do with the “prime” rate??? What do those journalist nerds have to do with setting the prime rate? And LIBOR? Who is responsible for dictating what these market reference rates are? Everyone keeps telling me the market but YTM is an OBSERVED rate of return, I can observe it as 100bps higher and lower whenever I want and last time I checked the market hasn’t crashed. I will not accept “the market” as an answer anymore. SOMEONE out there is setting the rates, can someone explain who sets the rates? Is it an algorithm (the market?) or some guy at the fed, or a combination?
As you can see I dont have a finance background so fixed income is getting hairy because all these “rates” and market reference “rates” are popping up and everyone just keeps telling me the market decides but I dont understand that answer. Thanks in advance