leveraged floater payments, interest, planning, net, 400

John10

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!

zwjy

Thanks, pfcfaataf.

$12m has to be the NP, o/w, there is no enough info to calculate the net cash flow.

aidebaobao

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"

agree / disagree?

bkballa

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

Colum

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.

PalacioHill

the inverse floater is next to it.

pennyless

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)

ll11

i saw a leveraged floater in the men's room earlier

Analti_Calte

Is A the final answer?

Is this $12 million the notional principal?

ohai

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?