Leveraged Floater. JMI has issued a $12 million leveraged floater with semi-annual interest payments. The rate is 1.2 times LIBOR. The firm is planning to hedge the risk of this note with a bond paying 6 percent and a swap with a fixed rate of 4.4 percent. In Situation 4, the net semi-annual cash flow is closest to: A) $115,200. B) $230,400. C) $96,000.
A
A is correct based on CFAI logic I do not agree how they present this lev. fl. hedge…
Yes, it is A… Can someone explain? I really dont understand them…
You can refer to the text.
alta168 Wrote: ------------------------------------------------------- > You can refer to the text. Good hint… finally found the topic is not in notes!
hellscream Wrote: ------------------------------------------------------- > alta168 Wrote: > -------------------------------------------------- > ----- > > You can refer to the text. > > > Good hint… finally found the topic is not in > notes! V5 Reading 43, pg 490 V5, Reading 43, pg 530, practice problem no. 3 Do this: Pay leveraged floater: -1.2L (Principal) From bond: + 6% x 1.2(Principal) Floating side of swap: + L x 1.2(Principal) Fixed side of swap: - 4.4% x 1.2((Principal)) End result: (6-4.4)% x 1.2 (Principal) = 1.6% x 1.2 x 12,000,000 = 230,400 But since it is semi annual the answer is 230,400 / 2 = $115,200
This is the part of the text i can never figure it out. Where does the firm get the money to buy a 1.2 prinicpal bond?
So the bond amount should be the same as the swap notional? Leveraged Floater issued means 1.2Libor liability on 12m Swap on 14.4m = libor vs 4.4 = 1.2libor on 12m vs 5.28% on 12m so we just need to finance the 4.4% on the 14.4m swap =0.6336m We have 12m from issuance of the floater so shouldnt we just long a 12m 6% bond? which would cover the swap and leave 86,400 pa or 43,200 semi annual?
(6%-4.4%)*(1.2*12m)=$230,400. semi-annual net cash flow: $230,400/2=$115,200.
To me, this question is incomplete. We’re paying: 1.2*LIBOR on an inverse floater Receiving: 4.4% on a swap 6% on a bond Yet, the question doesn’t specify the terms of the floating rate side of the swap. Is it LIBOR flat, or LIBOR plus a spread? Obviously, for hedging purposes we can assume the floating rate could be 1.2*LIBOR but that may be an unrealistic assumption.
you are wrong leverage floater needs buy 1.2 x amount in bond and swaps it recieve semiannual 1.2x3% and pay 1.2x2.2% LIBOR offset so the answer is A
i try to remember in the leveraged floaters the floating payments cancel each other out and the net result is the difference between the fixed rate entities multiplied by the leverage factor (1.2)
SkipE99 Wrote: ------------------------------------------------------- > i try to remember in the leveraged floaters the > floating payments cancel each other out and the > net result is the difference between the fixed > rate entities multiplied by the leverage factor > (1.2) Thank you, I’m just going to memorize and move on. I’m assuming you’re always going to subtract the fixed rate on the swap from the fixed rate from the bond?
SkipE99 Wrote: ------------------------------------------------------- > i try to remember in the leveraged floaters the > floating payments cancel each other out and the > net result is the difference between the fixed > rate entities multiplied by the leverage factor > (1.2) notes taken…concise and accurate.
deriv108 Wrote: ------------------------------------------------------- > SkipE99 Wrote: > -------------------------------------------------- > ----- > > i try to remember in the leveraged floaters the > > floating payments cancel each other out and the > > net result is the difference between the fixed > > rate entities multiplied by the leverage factor > > (1.2) > > notes taken…concise and accurate. I am with you…
SkipE99 Wrote: ------------------------------------------------------- > i try to remember in the leveraged floaters the > floating payments cancel each other out and the > net result is the difference between the fixed > rate entities multiplied by the leverage factor > (1.2) This is always I remembered it but I thought I was taking a short cut and therefore wasn’t comfortable with it. so I think now there is nothing to worry about if you remember it this way.