A discount margin is the amount of return that is earned over and above a specific reference rate associated with some type of floating rate security. The actual amount of the margin depends on the price of the security as of a certain date, and how that price compares to the reference rate. Projecting the discount margin over the life of the floating rate note or security is helpful to investors, since it sets reasonable expectations for the amount of return that is earned from the point of sale to the maturity date.
Depending on the current status of the security price, the discount margin may begin at zero and increase from that point. Only in highly unusual circumstances would the margin fall into a negative figure. This is especially true with bonds, which often ensure that even if the investor does not earn any money from the investment, he or she at least recovers the amount of the original purchase of the bond issue.
A discount margin may be zero when the current price is the same as the reference rate. This essentially means that up to that point, the asset has not earned anything above and beyond the anticipated rate of growth. It is not unusual for a floating rate security to experience this phenomenon early in the life of the asset. As time goes on, there is more of an opportunity for the discount margin to diverge from the reference rate as the security price begins to move upward.
It is important to note that the movement of the price of the floater or floating security affects the amount of the discount margin. This means that during the life of the security, there may be periods when the margin is higher than at other times. Should events take place which lower the price of the floater after a period of increase, the discount margin will adjust accordingly.
Investors consider the discount rate when evaluating the purchase of a floating rate security. By allowing for the probability that the rate will change over the life of the security, it is possible to determine what is considered the most likely progress of the security price. Should the return be more than this established standard or reference, then the discount margin increases. Investors often look for signs that upcoming trends in the marketplace may trigger this type of response, making it possible to ultimately earn more from the investment than was originally envisioned.
