Measuring Floating-Rate Loan Sensitivity Across Projection and Discount Curves
Summary
The document explains how a floating-rate loan's value responds to changes in its projection and discounting curves. It distinguishes the curve used to set future floating coupons from the funding or discount curve used to value cash flows. For an investment-grade loan whose mark is driven by rates, a parallel movement in both curves can cause the spread over the reference rate to behave like a fixed coupon and create profit or loss, while the index component of the coupons may be offset by changes in the present value of principal repayments.
The discussion cautions that distressed or defaulted debt may be driven more by recovery assumptions than by interest-rate sensitivity. It also recommends a broader risk view that considers changes in the spread between the two curves and non-parallel curve shocks, including larger moves and principal-component scenarios. The answer does not give a numerical valuation recipe or deal-specific result; sensitivities depend on the loan's credit condition, curve behavior, and modeling assumptions.
Key ideas
- Floating-rate loan valuation can depend on separate projection and discounting curves.
- A parallel shift in both curves can leave some index-linked coupon effects offset by principal valuation changes.
- The loan's contractual spread can retain sensitivity to discounting even when reference-rate effects offset.
- For distressed debt, recovery assumptions may outweigh interest-rate movements as a price driver.
- Risk analysis can include curve-spread sensitivities and non-parallel shocks beyond a single basis-point move.
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Full text
# Calculate how much 1 bp is worth in USD? # Calculate how much 1 bp is worth in USD? Suppose I have a loan where the cash flows and the discount rate are calculated using LIBOR + 100 bps If I wanted to calculate how much a unit of risk (1 bp) is worth in USD, I understand that I should only shift 1bp in the discounting curve - and NOT in the projected cash flows + discounting curve -, is this correct? Any insight on this would be appreciated! Then how much 1 bp would be worth, would be equal to the MTM change= Orig MTM - Shifted MTM. ## Answer by Dimitri Vulis (score 1) https://quant.stackexchange.com/a/68222 (Related discussion: IRS - sensitivity to estimation (projection, coupon) curve and discounting curve ) If the loan is HY/distressed/already defaulted, then its price is driven more and more by the recovery assumption, rather than by intrest rate. Some desks that specialize in distressed debt even have models that predict how much the recovery assumption is driven by interest rates. Still, it's a small sensitivity. Having said this, let us assume that the loan is IG and its mark is driven by the interest rates. You have two curves: 1 the curve used to project the unset coupons, i.e. the swap curve 2 your financing (funding, discounting) curve for this loan. If these two curves move in parallel, which is the most common behavior in the market, then you have lots of P&L from the "+100 bps" part of your coupons, because this part is only sensitive to the discounting curve - essentially a fixed coupon. But the P&L from the "index" part of your floating coupons will be offset by the P&L from the present value of the principal repayments. A more comprehensive set of interest rate risk measures might include the sensitivities to the spread between these two curves, and various scenarios other than a 1bp parallel shift, e.g. 2nd and 3nd principal components, larger shocks...
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