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?

Question

Quizplus · Accepted Answer

An inverse floater pays a variable rate of interest that moves in the opposite direction of a specified benchmark rate (in this case, LIBOR). Therefore, as LIBOR increases, the investor will receive a lower return on the security (Option B). If LIBOR is 4 percent, the asset will pay 5 percent to the investor (9% - 4% = 5%; Option A). The agency issuing this security may convert it into a LIBOR liability by entering into a swap agreement (Option C). 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 (9% - 10% = -1%; Option D). Therefore, all of these statements correctly reflect the characteristics of an inverse floater.

An FI Has Purchased an Agency Security That Is an Inverse