Yield spread measures for floating-rate securities, Financial Management

Assignment Help:

In a floating rate security, the coupon rate changes periodically as per the reference rate. The yield to maturity of floating rate securities cannot be calculated as the future value of the reference rates which determine the cash flows are unknown. Instead, conventional measures like spread for life, adjusted simple margin, adjusted total margin, and discount margin are used. Of these, the discount margin measure is more popular. The method for calculating discount margin is given below:

  1. First, cash flows are determined assuming that the reference rate does not change over the entire life of the floating rate security.

  2. Next, a margin is to be selected.

  3. Then, the cash flows found in step 1 are discounted using the current value of the reference rate plus the margin selected in step 2.

  4. The present value calculated in step 3 is then compared to the price plus accrued interest. If it is equal then the margin selected is the discount. If not, the process needs to be repeated with a different margin.

Let us illustrate this with an example.

Assume that the coupon reset formula for a Rs.100 par value, 4-year floating-rate security selling at Rs.98.4991 is the 6 month MIBOR plus 50 basis points. The interest rate is reset after every 6 months. The current MIBOR is 7.50%.

Table : Calculation of Discount Margin for a Floating-Rate Security

2180_yield measure for floating rate security.png

Cash flow for the period 1 to 7 is semiannual interest rate and for 8th period it is semiannual interest rate plus par value of the security.

   Annual Rate = MIBOR + Basis Points

   Semiannual rate = Annual rate / 2

   PV at assumed margin = Cash flow / (1 + Semiannual rate) time period

Discount margin as a measure of the returns form the floating rate security assumes that the reference rate will not change over the life of the security and it also does not take into consideration the cap and floor of the floating-rate securities. These are the two main drawbacks of this measure.


Related Discussions:- Yield spread measures for floating-rate securities

Trend analysis, Do you guys provide Trend Analysis assignment help? I need ...

Do you guys provide Trend Analysis assignment help? I need writing a report on Trend Analysis and it is about 2000 words. Let me know. I need to buy your solution.

Debentures, A 16% debenture of R5 000 is redeemable at a premium of 10% aft...

A 16% debenture of R5 000 is redeemable at a premium of 10% after 5 years. The fair rate of return on similar debentures is 14% before tax. Calculate the present value of the capit

Define mutually exclusive projects, Provide three examples of mutually excl...

Provide three examples of mutually exclusive projects. Mutually exclusive projects are projects which participate against each other for our selection.  If a organization and fir

How do financial managers calculate the average tax rate, How do financial ...

How do financial managers calculate the average tax rate? Financial managers calculate the average tax rate by dividing tax dollars paid by earnings before taxes (EBT).

Leverage, importance of Leverage

importance of Leverage

Illustrate compound value concept, Q. Illustrate Compound Value Concept? ...

Q. Illustrate Compound Value Concept? The Compound Value Concept is used to find out the FV of present money. It is the same as the concept of compound interest, wherein the in

Which type of insurance company generally takes risks, Which type of insura...

Which type of insurance company generally takes on the greater risks: a life insurance company or a property and casualty insurance company? The risks protected against by cas

Determine the examples of icq and iceq, Examples of ICQ's and ICEQ's I...

Examples of ICQ's and ICEQ's ICQ: "Does an authorised senior person review purchase invoices before payment is made?" ICEQ: "Can payments be made on purchase invoices th

Explain about discount rate, Q. Explain about Discount Rate? Discount R...

Q. Explain about Discount Rate? Discount Rate - Rate at which INTEREST is deducted in advance of the issuance, selling, purchasing or lending of a financial instrument. Also, t

Gdb.., Scenario: Brands and businesses in just about every industry are in...

Scenario: Brands and businesses in just about every industry are in a state of war with their competitors through promotions and marketing strategies. Majority of renowned brands

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd