Another name for the snow bear; a hybrid derivative instrument that is used by investors willing to bet on rising rates in a binary (digital) fashion. The payoff of a snow bear is calculated as the maximum of two values: an adjustable rate (usually incremental) or zero. The adjustable rate is given by the following formula:
Adjustable rate = previous coupon + accrual period factor × leverage factor × (floating rate − reference strike %)
Payoff = max (Adjustable rate , 0)
Where:
Accrual period factor is the percentage of months within a period to 12 months (e.g., for a 3-month accrual period, the accrual period factor is 3/12=0.25).
Leverage factor is usually determined by the investment bank (e.g., 0.4, 0.5, etc).
Floating rate is usually LIBOR for the same accrual period.
Reference strike is a minimum level which if the floating rate falls below, the adjustable rate automatically becomes zero.
The name “snow bear” presumably comes from the market observation maintaining that rising rates herald a bear market in stocks and bonds. The snow bear (like its original form the snowball) is a highly leveraged investment, and in specific unfavorable situations may wipe out an investor’s all future coupons.
This product is also known as a reverse snowball.
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