difference between floater bond and inverse floaters
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floating rate note (FRN), or floater, is a fixed income security that makes coupon payments that are tied to a reference rate. The coupon payments are adjusted following changes in the prevailing interest rates in the economy. When interest rates rise, the value of the coupons is increased to reflect the higher rate. Possible reference or benchmark rates include the London Interbank Offer Rate (LIBOR), Euro Interbank Offer Rate (EURIBOR), prime rate, US Treasury rates, etc.
On the other hand, an inverse floating rate note, or inverse floater, works in the opposite way. The coupon rate on the note varies inversely with the benchmark interest rate. Inverse floaters come about through the separation of fixed rate bonds into two classes: a floater, which moves directly with some interest rate index, and an inverse floater, which represents the residual interest of the fixed-rate bond, net of the floating-rate. The coupon rate is calculated by subtracting the reference interest rate from a constant on every coupon date. When the reference rate goes up, the coupon rate will go down given that the rate is deducted from the coupon payment. A higher interest rate means more is deducted, thus, less is paid to the debtholder. Similarly, as interest rates fall, the coupon rate increases because less is taken off.
On the other hand, an inverse floating rate note, or inverse floater, works in the opposite way. The coupon rate on the note varies inversely with the benchmark interest rate. Inverse floaters come about through the separation of fixed rate bonds into two classes: a floater, which moves directly with some interest rate index, and an inverse floater, which represents the residual interest of the fixed-rate bond, net of the floating-rate. The coupon rate is calculated by subtracting the reference interest rate from a constant on every coupon date. When the reference rate goes up, the coupon rate will go down given that the rate is deducted from the coupon payment. A higher interest rate means more is deducted, thus, less is paid to the debtholder. Similarly, as interest rates fall, the coupon rate increases because less is taken off.
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