Floaters Question

Bonds Mutual Funds is a fixed income fund specializing in investing in floaters trading in US bond market. The fund borrows from overnite repo market to lower the financial costs. A junior analysts of the fund is working on the floating bonds of XYZ company with a quoted margin of 80 bps over LIBOR. The Market price of the floating securities is $99.3098. Analyst repoted to the portfolio manager that the spread for life taking into account only the accretion of discount is 12.14 bps over the quoted margin. Had the analyst also taken into account the time value of money what would have been the spread over the quoted margin. The Analyst is also of the view that by holding the floater to its matuirty, that is 3 years from now, will substantially reduce the liquidity risk. Which of the following combination is correct. --------------------------------------------------------------- Spread(bps) Liquidity Risk -------------------------------------------------------------- A) 19.8296 || False B) 19.6541 || Depends upon the risk management of Bonds Mutual C) 19.1381 || No, but consider cap risk as the bond is trading at discount. D) 19.3098 || False

B. I don’t know how to calculate the spread, but liquidity risk will definitely go down

maturity of the floater is 6 years not 3 years.

C then woudl guess between C and B. C more likely

It is a stupid question, one of my self creation. So dont worry about it. All in all I am trying to design a question that covers lot of aspects of floaters. The concept is as YTM cannot be calculated for floaters, therefore margin is calculated. Simple margin do not take into account TVM but discount margin do. Also if the firm takes financing from repo and hold till maturity, it will not decrease liquidity risk. As repo is marked to market daily and the fund has to get fair value and it can significantly different from FV if the securities are illiquid.