I’m going through Wiley mock 1, and in the FI section, it asks to calculate the value of a floating rate bond with the coupong based on 12 month LIBOR + 320 bps, but it does not give the LIBOR rate. It gives the cap rate as 5.4% and gives the corresponding interest rates in the tree. Are we expected to find the LIBOR rate or am i missing an easy calculation?
Thanks!
^ Bump
I wonder if this is errata. Let’s say Libor was 0%… The floating rate coupon would be $3.2 (coupon is 12-month Libor + 320 bps). In the answer some of the values on the tree discount to less than par (less than $100) even though the discount rate is less than 3.2%. I can’t believe how much time I’ve wasted on this question.
I normally don’t post questions and try to figure out answers on my own, but this one really has me stuck.
Also, the question immediately after may also be errata.
The vignette states that the short rate will decrease and the long rate will increase.
The answer says this is both LEVEL and steepness.
Also, the answer’s explanation sites that BOTH long and short rates are expected to decline so that is why the LEVEL changes…
I figured it out. The question is based on a blue box in the text (p 358-360) related to capped floaters. Basically the rates given are the LIBOR and you add 3.2% to that. You use that rate as both the discount and coupon and you should get the answer of 99.856. Obviously, if the coupon rate surpasses 5.4% you would cap it at that, but discount at the LIBOR + 320 bps rate.
I don’t understand the concepts of the second question. I’ve read it over a few times and i just dont care anymore. I thought curvature would be involved at some point.
Edit: get the second question and its right. Explanation in the answers misstates that the LT rate declines as well. By process of elimination, since there is no curvature, A is the right answer.