Discount Margin (DM)

The notion of discount margins is applied to floating-rate securities, which pay coupons based on an underlying benchmark such as Libor plus a spread. The value of FRNs is based on uncertain future cash flows as it is not known at purchase what the coupons will be as they fluctuate based on changes in the underlying index. The quoted margin on an FRN is the spread the bond pays above or below the underlying index. The quoted margin reflects the return required to compensate investors for the credit risk they take on when investing. If an issuer’s credit risk worsens or improves, the market’s perceptions of the quoted margin will change too. The difference between the quoted margin and the spread the market now requires for the FRN to trade at par is the required margin, or the discount margin.