An inverse floater note is a structured product where the coupon of the bond is based on a formula which produces coupons that increase as the defined floating reference rate decreases. The rate is calculated as follows:
Fixed rate – floating reference rate x gearing factor
As a result this rate is inversely related to the interest rate from which it is calculated. That is, it rises as the reference rate falls and falls as the reference rate rises.
You can also specify minimum and maximum coupon values.
There are two styles of inverse floater note, the difference between them being in whether the instrument can be terminated (or called). In a:
Non-callable style of inverse floater note the instrument cannot be called.
Bermudan style of inverse floater note (also known as a callable inverse floater note), one of the parties has the right but not the obligation to terminate the range accrual swap on any of the predefined fixing (or termination) dates during the life of the swap.
In an inverse floater note the right to cancel the instrument early always belongs to the payer of the structured leg, i.e., the issuer of the note. The issuer will cancel the note when it expects the specified reference rate to keep dropping.
Although there is no penalty for terminating the note on any of the predefined dates, the coupon paid will generally be higher than that of a non-callable inverse floater note. This higher coupon is the price paid for having the right to call the instrument.
Advantages of an Inverse Floater Note
A structured bond has a structured swap behind it. In addition to being able to value the underlying swap using the callable inverse floater swap, bond structurers can also directly structure the bond themselves using the callable inverse floater note. This instrument lets the bond structurer enter the structure and see the price of the bond assuming a specific funding level.
Pricing an Inverse Floater Note in SDX Interest Rates
When pricing an inverse floater note in SDX Interest Rates the following must be specified:
Whether the note is callable or non-callable.
The floating index on which the structured leg is based.
The gearing to be used in the coupon formula.
The minimum and maximum coupons to be paid by the payer of the structured leg.
The Face Amount.
It is also important to note that:
If you choose to make the note callable, then by default the system sets the call dates to match the start dates of the underlying coupons using the call frequency.
In the Callable Dates and Fees window (accessed by clicking the Call Dates button in the pricing page) you can then edit the notice dates and also cancel any of the automatically scheduled call dates. For more information on working in this window, see Working in the Callable Dates and Fees Window.
The system returns the bond price assuming a specific funding level.
SDX Interest Rates calculates the market rate so as to give a zero NPV. This represents the fixed rate used in the calculation of the structured leg payout formula. The market rate can be changed, resulting in a non-zero NPV.