How Does an "Inverse Floater" Work?

The inverse floater is a security with an inverse relationship to interest rates. Here are the basics of an inverse floater and how it works.

Inverse Floater

With bonds, you will have a certain coupon rate that represents the amount of interest that you are going to be paid from the bond issuer. With most bonds, you will have a set coupon rate that will remain the same for the life of the bond term. Other bonds have variable coupon rates that fluctuate with market interest rates. In this situation, you have an interest rate that is actually moving in the opposite direction of market interest rates. Therefore, not only do you have a variable coupon rate bond, the coupon rate has an inverse relationship to market interest rates.

Benefit

With this type of bond you could potentially benefit in a few different ways. For example, if you purchased an inverse floater, you would be able to hedge your investments against declining interest rates in the market. The value of the bond can appreciate when interest rates that are in the market decline. This makes them a particularly attractive investment for many individuals that like the bond market.

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