A floating-rate note (floater) which as an embedded short cap on a face amount bigger than the face value of the note. The note’s coupon decreases as interest rates rise above the cap rate because the loss on the cap accumulates faster than the gain on the underlying rate.
In essence, this floater is a bond that behaves like a floating-rate note when the underlying index moves below a specific level, and behaves like a leveraged inverse floater when the underlying index moves above that level. The following example illustrates the notion of a leveraged capped floater:
A 5-year bond may pay over its life 6-month LIBOR plus 60 basis points if 6-month LIBOR is trading below 7%, and 22.7%- 2 × 6-month LIBOR if 6-month LIBOR is equal to, or greater than, 7%. In this sense, the minimum coupon that the bond could pay is 0%, and the maximum coupon is 22.7 – 2 × 7% = 8.7%.
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