Inverse Floater

<body onLoad="MM_checkPlugin('Shockwave Flash','','http://www.riskglossary.com/default_nofl.htm',false);return document.MM_returnValue" stylesrc="../_private/template.htm" bgcolor="#FFFFFF" link="#669933" vlink="#000000" alink="#000000"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table1"> <tr> <td width="740"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" height="37" id="table2"> <tr> <td height="35" width="100%"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" id="table3"> <tr> <td width="100%" align="left" valign="top"> <p class="header_gold">Inverse Floater</td> <td width="45" align="right" valign="bottom"> <map name="FPMap6"> <area href="http://www.contingencyanalysis.com" shape="rect" coords="1, 0, 44, 11" target="_top"> </map> <img border="0" src="../images/home.gif" usemap="#FPMap6" width="45" height="12"></td> </tr> </table> </td> </tr> <tr> <td width="100%" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td width="0%" valign="top" bgcolor="#FFFFCC"> <table border="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" cellspacing="1" id="table4"> <tr> <td width="0%" align="left" valign="top"> <p class="header2_black">Explained:<br> <img border="0" src="../images/blank_1x100.gif" width="100" height="1"></td> <td width="100%" align="left" valign="top"><p class="word_list"> <a href="#coupon leverage">coupon leverage</a><p class="word_list"> <a href="#inverse floater">inverse floater</a><p class="word_list"> <a href="#inverse CMOs">inverse floater CMO</a><p class="word_list"> <a href="#leveraged inverse floater">leveraged inverse floater</a><p class="word_list"> <a href="#reverse floater">reverse floater</a><br> <img border="0" src="../images/blank_1x160.gif" width="160" height="1"></td> </tr> </table> </td> </tr> </table> <p class="body">An <b><a name="inverse floater">inverse floater</a></b> (or <b><a name="reverse floater">reverse floater</a></b>) is a <a href="../articles/floater.htm">floater</a> whose <a href="../articles/coupon_bond.htm">coupon</a> fluctuates inversely with its reference rate—increasing when the reference rate decreases and decreasing when the reference rate increases. With each coupon payment, the floating rate is reset for the next period according to the formula:</p> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" height="36" id="table5"> <tr> <td width="100%" align="center"> floating rate = fixed rate – coupon leverage <img border="0" src="../symbols/multiplication_symbol.gif" align="absbottom" width="7" height="11"> reference rate</td> <td width="5%" align="right">[1]</td> </tr> </table> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="345" align="right" id="table6"> <tr> <td align="right" width="9" height="14"></td> <td width="336" height="14"> <font size="4"> </font></td> </tr> <tr> <td align="right" width="9"> </td> <td width="336"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> </tr> </table> <p class="body">The multiplier is called the <b><a name="coupon leverage"> coupon leverage</a></b>. Often, it is equal to 1, but not always. If it exceeds 1, the instrument is called a <b> <a name="leveraged inverse floater">leveraged inverse floater</a></b>.</p> <p class="body">Inverse floaters have been issued by <a href="../articles/corporation.htm">corporations</a> or <a href="../articles/agency_securities.htm">government-sponsored enterprises</a> as intermediate-term notes. A typical structure might have a maturity of five years, pay interest quarterly, and offer a floating rate of 12% minus two times a reference rate of 3-month <a href="../articles/currency_codes.htm"> USD</a> <a href="../articles/libor.htm">Libor</a>. There might also be a cap and/or floor for the floating rate.</p> <p class="body"> <a href="../articles/collateralized_mortgage_obligation.htm"> Collateralized mortgage obligations</a> (CMOs) are sometimes structured as inverse floater <a href="../articles/securitization.htm">tranches</a> called <b><a name="inverse CMOs">inverse floater CMOs</a></b>. If collateral is fixed rate mortgages, offsetting floater and inverse floater tranches are paired. In this way, fixed coupons are split into floating and inverse floating coupons.</p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="345" align="left" id="table7"> <tr> <td width="336"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> <td width="9"> </td> </tr> </table> <p class="body"><a href="../articles/valuation.htm">Market values</a> of floaters tend to be unstable. Their <a href="../articles/duration_and_convexity.htm">durations</a> are typically very high. They have in the past been popular with investors who wanted to bet on a decline in interest rates. </p> <p class="body" style="margin-bottom: 18">During the 1990s, inverse floaters gained a bad reputation. Money market funds are typically restricted to investing in money market instruments with maturities under a year. Many make an exception for floaters with maturities in excess of a year because these have durations under a year. Managers of some money market funds used this as a loophole and invested in inverse floaters as a way to bet on the direction of interest rates. When those bets went bad, the funds incurred losses not typical of money market funds. Several affected fund companies stepped in and made up the losses with their own money. It is unlikely they will let the same thing happen again.</p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table8"> <tr> <td height="30" valign="bottom" colspan="2"> <p class="header2_black">Related Internal Links</td> </tr> <tr> <td colspan="2" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td bgcolor="#FFFFCC" colspan="2"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="6" id="table9"> <tr> <td width="100%"> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/cap.htm">cap</a> A type of derivative instrument that offers protection against rising interest rates.<p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/collateralized_mortgage_obligation.htm">collateralized mortgage obligation</a> A type of mortgage-backed security.</p> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/credit_risk.htm">credit risk</a> Risk due to uncertainty in a counterparty's ability to meet its obligations.</p> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/duration_and_convexity.htm">duration and convexity</a> Factor sensitivities indicating first order (linear) and second order (quadratic) sensitivity to parallel shifts in the spot cure.<p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/fixed_income_term_structure.htm">fixed income term structure</a> Refers collectively to a spot curve, forward curve, discount curve, yield curve or any other curve that describes the time value of money at a particulate point in time.</p> <p align="left" class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/floater.htm">floater</a> A fixed income instrument whose coupon fluctuates with some designated reference rate.</p> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/floor.htm">floor</a> A type of derivative instrument that offers protection against declining interest rates.</p> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/mortgage_backed_security.htm">mortgage backed security</a> A security interest in mortgage collateral.</p> </td> </tr> </table> </td> </tr> <tr> <td height="30" valign="bottom" colspan="2"> <p class="header2_black">Sponsored Links</td> </tr> <tr> <td colspan="2" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td bgcolor="#FFFFCC" width="75"> <img border="0" src="../images/ad_side_banner_2.jpg" width="103" height="285"></td> <td bgcolor="#FFFFCC" width="99%">  <p class="ad_legend" style="margin-left: 0; 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Fabozzi, S. Mann and M. Choudhry</b></td> </tr> <tr> <td width="10%"> <map name="FPMap355"> <area target="_blank" href="http://www.riskbook.com/main/ratings.htm" shape="rect" coords="0, 0, 89, 15"> </map> <img border="0" src="../images/star_5.gif" usemap="#FPMap355" width="90" height="16"></td> <td width="10%" class="author">quality</td> <td width="70%"> <p class="author"> </td> </tr> <tr> <td width="10%"><map name="FPMap39"> <area target="_blank" href="http://www.riskbook.com/main/ratings.htm" shape="rect" coords="0, 0, 89, 15"> </map> <img border="0" src="../images/tech_2.gif" usemap="#FPMap39" width="90" height="16"></td> <td width="10%" class="author">technical</td> <td width="70%">  </td> </tr> <tr> <td width="10%"> <p class="author">2002</td> <td width="10%"> </td> <td width="70%"> <p align="center"><map name="FPMap37"> <area target="_blank" coords="0, 0, 145, 19" shape="rect" href="http://www.riskbook.com/link/fabozzi_mann_choudhry_(2002).htm"> </map> <img border="0" src="../images/pointer_review.gif" usemap="#FPMap37" width="146" height="20"></td> </tr> </table> </td> </tr> </table> <table border="0" cellpadding="4" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table13"> <tr> <td width="100" align="left" valign="top"> <map name="FPMap371"> <area target="_blank" href="http://www.riskbook.com/link/fabozzi_f_(2001).htm" shape="rect" coords="0, 0, 84, 124"> </map> <img border="0" src="../images/book_fabozzi_MBS_125.gif" usemap="#FPMap371" width="85" height="125"></td> <td align="left" valign="top"> <table border="0" cellpadding="1" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table14"> <tr> <td width="90%" colspan="3"> <p class="title"> <a target="_blank" href="http://www.riskbook.com/link/fabozzi_f_(2001).htm"> Handbook of Mortgage-Backed Securities</a></td> </tr> <tr> <td colspan="3"> <p class="author"><b>Frank Fabozzi (ed.)</b></td> </tr> <tr> <td width="10%"> <map name="FPMap362"> <area target="_blank" href="http://www.riskbook.com/main/ratings.htm" shape="rect" coords="0, 0, 89, 15"></map> <img border="0" src="../images/star_6.gif" usemap="#FPMap362" width="90" height="16"></td> <td width="10%" class="author">quality</td> <td width="70%"> <p class="author"> </td> </tr> <tr> <td width="10%"><map name="FPMap368"> <area target="_blank" href="http://www.riskbook.com/main/ratings.htm" shape="rect" coords="0, 0, 89, 15"> </map> <img border="0" src="../images/tech_2.gif" usemap="#FPMap368" width="90" height="16"></td> <td width="10%" class="author">technical</td> <td width="70%">  </td> </tr> <tr> <td width="10%"> <p class="author">2001</td> <td width="10%"> </td> <td width="70%"> <p align="center"><map name="FPMap369"> <area target="_blank" coords="0, 0, 145, 19" shape="rect" href="http://www.riskbook.com/link/fabozzi_f_(2001).htm"> </map> <img border="0" src="../images/pointer_review.gif" usemap="#FPMap369" width="146" height="20"></td> </tr> </table> </td> </tr> </table> </td> </tr> </table> </td> </tr> <tr> <td height="30" valign="bottom" colspan="2"> <p class="header2_black">Sponsored Links</td> </tr> <tr> <td colspan="2" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td bgcolor="#FFFFCC" width="75"> <img border="0" src="../images/ad_side_banner_1.jpg" width="103" height="285"></td> <td bgcolor="#FFFFCC" width="99%"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> </tr> <tr> <td bgcolor="#FFFFCC" colspan="2"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="6" id="table15"> <tr> <td width="100%" bgcolor="#FFFFFF"> <p align="center"><map name="FPMap365"> <area target="_top" href="http://www.riskglossary.com" shape="rect" coords="0, 0, 164, 102"> </map><img border="0" src="../images/logo.jpg" usemap="#FPMap365" width="165" height="103"></p> <p align="center"><span class="verdana10"> <a href="http://www.riskglossary.com/main/disclaimer.htm" target="_self"> Disclaimer</a></span></p> <p align="center">website: <span class="verdana10"> <a target="_top" href="http://www.contingencyanalysis.com"> http://www.contingencyanalysis.com</a></span><br> glossary direct link: <span class="verdana10"> <a target="_top" href="http://www.riskglossary.com"> http://www.riskglossary.com</a></span><br> copyright © Contingency Analysis, 2002</td> </tr> </table> </td> </tr> </table> </td> <td>  </td> </tr> </table> </body>