Inverse Floater

Posted in Finance, Accounting and Economics Terms, Total Reads: 110
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Definition: Inverse Floater

Inverse Floater is a type of bond in which coupon rate of the bond is not fixed and is inversely related to short term interest rate. In short, if the short term interest rate is low then the coupon rate will be high yielding high returns and when short term interest rate is high the coupon rate will be high.


When short term rates increase inverse floater receives double hit: firstly the Present value of future cash flow decreases and secondly the Coupon rate is less.


Similar to Inverse floating rate bonds, there are Floating rate bonds in which coupon rate is not fixed but the differentiating factor between Floating rate bonds and inverse floating rate bonds is that coupon rate is directly related to short term interest rate


The Table below is the example showing the coupon rate in Floating rate bonds and Inverse Floating rate bonds

Interest rate (A)

Short term interest rate (B)

Inverse Floating Rate (A-B)

Floating rate  (B)

10%

4%

6%

6%

10%

5%

5%

5%

10%

6%

4%

6%

10%

7%

3%

7%

10%

8%

2%

8%

10%

9%

1%

9%


Interest rate (A)

Short term interest rate (B)

Inverse Floating Rate (A-B)

Floating rate  (B)

10%

4%

6%

6%

10%

5%

5%

5%

10%

6%

4%

6%

10%

7%

3%

7%

10%

8%

2%

8%

10%

9%

1%

9%

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