A floater (FRN) that pays a high fixed rate coupon for an introductory period (first one or two years), then it pays the difference between an even higher fixed rate coupon and a floating reference rate (LIBOR). For example, this floater can be structured as follows:
- Over the first two years: it pays 10%.
- From the third year on, it pays: 15% – LIBOR.
Investors who expect short-term rates to fall in a future period can earn very large coupons. However, if such expectations are off-the-mark, huge losses would result.
Comments