An FI has purchased an agency security that is an inverse floater at 9 percent minus LIBOR. Which of the following characteristics reflect this type of asset?
A)If LIBOR is 4 percent, the asset will pay 5 percent to the investor.
B)As LIBOR increases, the investor will receive a lower return on the security.
C)The agency issuing this security may convert it into a LIBOR liability by entering into a swap agreement.
D)If the FI funded the asset at LIBOR, and LIBOR reaches 10 percent, the FI will have a negative 10 percent spread on the asset.
E)All of the options.

Question

Quizplus · Accepted Answer

An inverse floater has an interest rate that moves in the opposite direction of the underlying benchmark rate. In this case, the security pays 9% minus LIBOR, meaning that as LIBOR goes up, the return on the security goes down. If LIBOR is at 4%, the investor would receive 5% on the security (9%-4%). The agency issuing the security could potentially swap it into a floating rate liability (i.e. a LIBOR liability) depending on their needs. If an FI funded the asset at LIBOR and LIBOR increased to 10%, then the spread on the asset would be -1% (9%-10%). Therefore, all of the options apply to this type of asset.

An FI Has Purchased an Agency Security That Is an Inverse