What is an inverse floating rate tranche? How is the coupon calculated?
Inverse floating rate tranches have a class coupon that are reset periodically based on an interest rate index such as the London Interbank Offered Rate (LIBOR) and that vary inversely with changes in the interest rate index. The inverse floater can be leveraged or non-leveraged. The interest rate on leveraged inverse floaters moves up or down more than one basis point with every decrease or increase of one basis point on the index. The interest rate on a non-leveraged floater moves up or down inversely to the index on a one-to-one basis. Inverse floating rate bonds tend to perform better as interest rates decline. Investors who seek higher yields in a declining interest rate environment tend to be interested in inverse floating rate tranches. Investors may also use inverse floating rate tranches to hedge interest rate risks in portfolios.
