Dear David,
I’ve have struggling with the following question from FRM practice and past exams. Appreciate your kind help on this!
7) On CLN valuation(FRM handbook 5th edition, Example 22.15 page 550)
A three-year, credit-linked note (CLN) with underlying company Z has a LIBOR + 60 bps semi-annual coupon. The face value of the CLN is USD 100. LIBOR is 5% for all maturities. The current three-year CDS spread for company Z is 90 bps. The fair value for the CLN is closet to
a. USD 100.00
b. USD 111.05
c. USD 101.65
d. USD 99.19
Answer provided is d USD 99.19.
My question: I used the following methods but get the answer b, USD 111.05. Can you please correct me?
I think its fair value should be equal to a hypothetical bond with semi-annual coupon rate of 5.6% and yield to maturity of 5.9%, given that the LIBOR is flat at 5% for all maturities. Therefore I computed the price by discounting semi-annually the 3 year cash flow of this hypothetical bond with the discount factor (1+5.9%/2). The result turns out to be different from the correct answer. Can you please kindly point our my mistakes and misunderstanding?
Thank you for your enlightenment and correction!
Cheers
Liming
10/11/09
I’ve have struggling with the following question from FRM practice and past exams. Appreciate your kind help on this!
7) On CLN valuation(FRM handbook 5th edition, Example 22.15 page 550)
A three-year, credit-linked note (CLN) with underlying company Z has a LIBOR + 60 bps semi-annual coupon. The face value of the CLN is USD 100. LIBOR is 5% for all maturities. The current three-year CDS spread for company Z is 90 bps. The fair value for the CLN is closet to
a. USD 100.00
b. USD 111.05
c. USD 101.65
d. USD 99.19
Answer provided is d USD 99.19.
My question: I used the following methods but get the answer b, USD 111.05. Can you please correct me?
I think its fair value should be equal to a hypothetical bond with semi-annual coupon rate of 5.6% and yield to maturity of 5.9%, given that the LIBOR is flat at 5% for all maturities. Therefore I computed the price by discounting semi-annually the 3 year cash flow of this hypothetical bond with the discount factor (1+5.9%/2). The result turns out to be different from the correct answer. Can you please kindly point our my mistakes and misunderstanding?
Thank you for your enlightenment and correction!
Cheers
Liming
10/11/09
