Leveraged Floaters

Reading 31, page 455 (CFA text) Example 3. I get the first cash flow “-2L FP” but why is the next one “+(ci)2(FP)”? Specifically, why is it “2FP”?

Really struggling with reading 31…anyone else?


Nevermind - I just realized I don’t care.

Hopefully they ask us to structure adding a syntheticic call feature to a bond

This is one of the tricky little bits of the curriculum I hope doesn’t show up and won’t even attempt if it does!

Diminishing returns and all that!

I think all you need to know there for the exam is you by ‘X’ * NP of the bond, equal to the multiple of the FRN pays on Libor, if you look at the picture on the LHS page you will see the same, and in the text.

I would imagine it has something to do with the pricing of FRN’s that pay a multiple of the appropriate rate as PV Floating side = Par (provided the coupon = the appropriate discount rate) on a reset date, which wouldn’t be the case if a FRN is paying a multiple but thats a guess and doesn’t help here…

Just remember buy the same multiple of the fixed rate bond’s FV as the FRN pays on Libor and youll be right.

"A company issues a floating-rate note that pays a rate of twice LIBOR on notional principal FP. It uses the proceeds to buy a bond paying a rate of ci. It also enters into a SWAP with a fixed rate of FS to manage the risk of the LIBOR payment on the leveraged floater. "

They are using the following calculation to derive the net cash flows

  • From leveraged floater -2L (FP)

-From bond +(ci) 2 (FP)

-floating side of SWAP +(L) 2 (FP)

-fixed side of SWAP -(FS) 2 (FP)

Total 2FP(ci-FS)

I really don’t understand this result of 2FP (ci-FS). --> Shouldn’t it be 1FP only (-FP +2FP +2FP - 2FP)? And why ci-FS?

sum up all the 4 cash flows you have

  • From leveraged floater -2L (FP)

-From bond +(ci) 2 (FP)

-floating side of SWAP +(L) 2 (FP)

-fixed side of SWAP -(FS) 2 (FP)

What makes them think that the proceeds from issuing the leveraged floater will be twice the notional principal?

That makes no sense, unless the floater is perpetual.

This “twice” the notional principal has been a part of the curriculum in this section from a very long time back.

and each year the question is asked on the forum about this same thing.

(and there has been NO resolution).

I sent an e-mail to CFA Institute. I’ll let y’all know what they say.

Thanks magician! Looking forward to some news on this.

I guess no response from CFAI yet? :frowning_face:

Quite the contrary: a very interesting response from CFA Institute. Finally.

Their first response was that they reviewed it and that it was correct in the important particulars.

I replied to their response and respectfully disagreed with their conclusion, asking to be allowed to discuss the matter with the reviewers.

Their second response conceded that there were errors that needed to be corrected, but that, as no LOS specifically applies to that calculation, they were going to let it lie.

So it sorta sounds like I won. Kinda.