we promise to pay say 2xLIBOR on a floating note we issued of principal FP. the text says that you now invest into bonds an amount equal to 2xFP and earn a fixed rate. then you swap using 2xFP as notional principal, pay fixed and recieve LIBOR… so u recieve LIBOR on 2xFP which offsets your payment on the floating rate note. question- where did you get the 2xFP money to invest around. when you originally issued floaters you recieved only FP… so where do u get an extra FP so as to invest in bonds ?
Repo but there’s no money machine here. If you have $x, you’re going to earn interest on a net of $x. Edit: It’s 2x LIBOR minus something right?
It’s not inverse floater, it’s leveraged FRN
structured notes are not in any LOS… but CFA has not published any errata on this saying “should be marked as optional”… That is scarying. anyway, for leveraged notes, I guess calculations are not very correct. As Joey said, if they get FP from the bond, and must buy 1.5FP of other bond, the 0.5FP must come from somewhere, and I am sure it is not for free… But cfa text does not mention any cost associated with that additional principal…
hala_madrid Wrote: ------------------------------------------------------- > structured notes are not in any LOS… but CFA has > not published any errata on this saying “should be > marked as optional”… That is scarying. > > anyway, for leveraged notes, I guess calculations > are not very correct. As Joey said, if they get FP > from the bond, and must buy 1.5FP of other bond, > the 0.5FP must come from somewhere, and I am sure > it is not for free… But cfa text does not > mention any cost associated with that additional > principal… yeah, i was wondering the same… where did they get that additional 0.5 to buy bonds?
sorry… error …its leveraged floaters but the text doesn’t mention where you get the extra money from… the math works out but where is the money from… no idea
You don’t technically put out the extra money, i believe. If you are 2x libor, its as if you were paying Libor on 2x the Notional.
willy that is true but when you issue 2xfloater, how much money do you get back? definetly not 2xNotional
I think the book is messed up on this. I think it was last year too.
When you issue a 2x floater usually you pay 2x LIBOR - swap rate.
You only get the notional. For instance if it was a 2x Pay Libor receive 6% on $1M, and Libor was 4%, you would pay 2x4% = 8% * $1M = 80,000 and you would receive 60,000, so NET you would pay out 20,000
I asked the very same question to stalla instructor when he came for a two day session at my workplace. When I asked him where does one get 2 times the notional to purchase the bond, he thought of borrowing. but then the problem is the cost of lending is not to be seen anywhere in the formula as a deduction…he seemed to agree that there is a problem with this. Just hope that this problem does not come in our exam and even if it does, just forget about all this and use the formula that they have given… I can imagine how much frustrating it could be(since I kept thinking about this issue for long)…