24-57 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 as the security pays a fixed rate of 9 percent and the variable rate is LIBOR. Therefore, if LIBOR is 4 percent, the investor will receive a net return of 5 percent.
B) This is correct as an inverse floater has a negative correlation with the reference rate. As LIBOR increases, the interest paid on the security decreases.
C) This is possible as the agency issuing the security has the ability to enter into a swap agreement to convert the security into a floating rate liability.
D) This is correct. If the FI funded the asset at LIBOR and LIBOR increases to 10 percent, the yield on the asset would be -1 percent (9 percent - 10 percent LIBOR). This would result in a negative spread for the FI.

24-57 an FI Has Purchased an Agency Security That Is