Interest rate floor for LIBOR - Exam 3 pm discounted, understand, absolute, interest

Matori

I don’t understand question 93 in the pm Exam 3:
If 1-year LIBOR at the end of year 2 is 5.8%, the absolute value of a position (long or short) in the 2-year, 6%, $30 million interest rate floor at the end of year 2 is closest to:
A. $56,711
B. $60,000
C. $63,480
Can someone please tell me why the payoff needs to be discounted? It’s not like it’s a FRA.

dkishore1

The problem in the book - they are calculating what the payoff will be at the date of the settlement. In this one - you are calculating the value of the floor / cap - as of TODAY. So you need to discount the amount you would get at maturity - to today using the interest rate.

dontknow1987

in CFAI Volume6 page 304, they do not discount it. Anyone here can help!!!

svgleeson

This isn;t FRA – it is Interest rate stuff - chapter after Options (or possibly pushed into the options chapter) in Schweser.

former

Thanks guys! Think I need to review my FRA basics :s

cyber21

I’m assuming it’s because the rates given are for the next period so we have to discount them to today to find the value.
And yeah, I got A as well.