JMI has issued a $12 million leveraged floater with semi-annual interest payments. The rate is 1.2 times LIBOR. The firm is planning to hedge the risk of this note with a bond paying 6 percent and a swap with a fixed rate of 4.4 percent. The net semi-annual cash flow is closest to:
A) $115,200.
B) $230,400.
C) $96,000.
please show your cal and explanation. Thanks!作者: Zestt 时间: 2011-7-11 15:28
i feel there something missing out here ... JMI has a 'pay floating' obligation in first place.
to hedge, he must take the 'receive floating, pay fixed' side. there's no info on any receive floating leg of transaction. ???作者: strikethree 时间: 2011-7-11 15:28
B) 230,400
(0.06-0.044)*1.2*12,000,000
Just made it all up, no idea really作者: jmh530 时间: 2011-7-11 15:28
Its a leveraged floater so the swap and fixed bond cant have the same NP as the leveraged floater. it needs to be x up by 1.2.
The swap will have a 14.4m NP with Libor on the one leg and fixed on the other of 4.4%. This libor will cancel with the leverage floater libor. leaving the two fixed rates of 6% and 4.4% on a NP of 14.4m.
The annual receipt is 230,400. The semi-annual receipt is 115,200.作者: Roflnadal 时间: 2011-7-11 15:28
level3aspirant Wrote:
-------------------------------------------------------
> i feel there something missing out here ... JMI
> has a 'pay floating' obligation in first place.
>
> to hedge, he must take the 'receive floating, pay
> fixed' side. there's no info on any receive
> floating leg of transaction. ???
They have a floating obligation from the leverage floater. to fully hedge they purchase a swap but the fixed leg needs to be hedged as well with a fixed bond purchase.
Not very well worded question really.作者: canadiananalyst 时间: 2011-7-11 15:28
chedges Wrote:
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> A.
>
> Its a leveraged floater so the swap and fixed bond
> cant have the same NP as the leveraged floater. it
> needs to be x up by 1.2.
>
> The swap will have a 14.4m NP with Libor on the
> one leg and fixed on the other of 4.4%. This libor
> will cancel with the leverage floater libor.
> leaving the two fixed rates of 6% and 4.4% on a NP
> of 14.4m.
>
> The annual receipt is 230,400. The semi-annual
> receipt is 115,200.
Back to this question. How does this not require capital from JMI? They issue a 12MM bond but buy a 14.4MM bond. Where does the 2.4MM come from?作者: Darien 时间: 2011-7-11 15:29
so they raise the 12mill then do a 14.4mill swap and buy 14.4mill worth of bond paying 6% annually?
thanks作者: ohai 时间: 2011-7-11 15:29
Yeah I dont get it. it says in the book that "no capital in required to engage in this transaction".
I dont see how that is possible. You issue bonds. You get 12MM cash. Now you need 14.4MM in bonds. You have 12MM in cash. Are the bonds are a deep discount? WTF?作者: Analti_Calte 时间: 2011-7-11 15:29
Is A the final answer?
Is this $12 million the notional principal?作者: ll11 时间: 2011-7-11 15:29
i saw a leveraged floater in the men's room earlier作者: PalacioHill 时间: 2011-7-11 15:29
the inverse floater is next to it.作者: pennyless 时间: 2011-7-11 15:29
deriv108 Wrote:
-------------------------------------------------------
> Is A the final answer?
>
> Is this $12 million the notional principal?
yes $12 mio is the face value,
we do not know the price at which it was issued!!!
ref. CFAI text (Volume 5, page around 489)作者: bkballa 时间: 2011-7-11 15:29
You need 14.4 Million face value of bonds , but you have 12 Million in cash. There are some issuers that will go for a rate like that . Plus the term is not specified, could be 20 years in which case it will begin to look very reasonable作者: Colum 时间: 2011-7-11 15:29
To create a leveraged floater, the issuer has to set its price higher enough(or with longer term as janakisri said) to cover the liability(to pay 2xLIBOR rate).
The issuer can't do much about the bond(6%) and the swap(-4.4%), and he just uses the two to hedge the risks.
I'm not complaining, but CFAI can simply add a line or two to clarify the confusion in the KAT example (P489). I found it was asked in AF every year.作者: zwjy 时间: 2011-7-11 15:29
Thanks, pfcfaataf.
$12m has to be the NP, o/w, there is no enough info to calculate the net cash flow.作者: aidebaobao 时间: 2011-7-11 15:29
Overall I think this should work:
If issue a leveraged floater, buy a fixed bond, receive fixed and pay floating swap. Net payment fixed
If issue an inverse floater, buy a fixed bond, pay fixed and receive floating swap. Net payment fixed
Provided that for an inverse floater, the floating rate does not increase more than "b" as in "b - F"
