Fixed Income analysis

alwaysenjoy.indu
Posts: 3
Joined: Wed Jun 25, 2014 8:09 am

Fixed Income analysis

Postby alwaysenjoy.indu » Fri Jun 27, 2014 6:40 pm

What is the term Basis Points or Margins are referred to in Floating Rate Bonds ? How do we get that ?

edupristine
Finance Junkie
Posts: 722
Joined: Wed Apr 09, 2014 6:28 am

Fixed Income analysis

Postby edupristine » Sat Jun 28, 2014 11:05 am

Basis Point
It represents 1/100th fraction of 1%. (or simply 1% = 100 Basis Points)
So, if the yield of a bond rises from 6 to 6.5%, it means that the yield has increased by 0.5% or 50 basis points(BP).

Floating Rate Bonds
The interest on a floating rate bond is adjusted after regular intervals based upon movements in index or LIBOR etc as against a standard bond in which the rate of interest payable is fixed.

Reset Margin
The difference between the interest rate of a bond and the index on which the bond’s interest rate is based. For example, the interest rate of a floating-rate bond is based on LIBOR plus 0.8%. The 0.8% is the reset margin, meaning that if LIBOR is 1% then the interest rate on the bond is 1.8%.

What is Discount Margin and How to calculate it?
Discount Margin is the additional return earned in addition to the index underlying the floating rate bond, when it matures. In other words, Discount margin is the additional money an investor earns as a compensation for the increased risk he undertook by investing in an adjustable interest rate security.
Floating rate bonds are always sold below the Par Value. So, when it is sold, there is a chance to generate additional return

Now the amount of the discount margin depends upon the following three scenarios:
1) Negative Discount Margin: If Price paid at the time of buying Floating rate bond > Par Value of the bond at the time of maturity. So to calculate the discount margin, find out the difference between the price paid for buying the bond and par value at maturity. Subsequently, subtract this value from reset margin to arrive at discount margin.

2) Zero Discount Margin: If Price paid at the time of buying Floating rate bond = Par Value of the bond at the time of maturity. Here, no additional return has been generated. So, the Discount margin will be equal to the reset margin.

3) Positive Discount Margin: If Price paid at the time of buying Floating rate bond < Par Value of the bond at the time of maturity. The difference between the discount price and Par value is the additional return generated. To calculate discount margin, add this return to the reset margin.


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