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 above.

Question

Quizplus · Accepted Answer

A) This is correct. An inverse floater pays a fixed rate minus a floating rate, in this case 9% minus LIBOR. Therefore, if LIBOR is 4%, the investor would receive 5%.
B) This is correct. As LIBOR increases, the payout to the investor decreases. This is because the inverse relationship between the fixed rate and the floating rate.
C) This is possible. An agency issuing an inverse floater may use a swap agreement to convert the security into a LIBOR liability.
D) This is possible, as there is a negative spread when the floating rate exceeds the fixed rate.
Therefore, all of the above are correct.

An FI Has Purchased an Agency Security That Is an Inverse