I had already posted a bonus certificate on Brent Crude Oil several weeks ago, which would have performed quite well if … Readmore…
Single Products and Markets
Weblog about specific products and market opportunities
Inverse Floaters
Last week, I was convinced at last that there would be no or little inflation in the years to come. For those who subscribe to this point of view, the question about income from bond-like holdings arises. How do you re-invest a maturing bond? Short term-rates are a flat-liner, no chance of generating income through short-term money-market instruments; at best, the interest generated is barely sufficient to cover for the bank’s cost. The yield curve in EUR, USD or GBP is steep, but let’s face it, at 3.3% yield, a 10-year Bund yield still doesn’t look too flashy. So if I expect short-term rates to remain low for some time and I don’t want to commit myself to the long-term, I can play against the steepness of the curve with an inverse floater. Such an instrument has a payoff formula that looks like
[X% - 3-month Libor],
where X% is usually a relatively high constant compared to the money-market rate. For instance a 3-year structure would look like:
[4% - 3-month Libor]
With the USD 3-month Libor currently at 0.3%, the expected coupon in the first quarter would amount to 3.7%. As long as the Libor remains low, I would outperform classic bonds with the same credit risk profile and maturity. I can enhance the potential return if I put a small leverage in the formula:
[Y% - 2*3-month Libor]
where Y% would amount to, say 6.5%. Depending on the risk I am willing to take, I can leverage more or less. The higher the leverage, the higher the chance that the coupon falls to zero at the slightest short-term rate increase. Advantage of this structure: it’s not path-dependant, meaning that even if short-term rates increase for a quarter and diminish the coupon for that period by so much, a decrease in rates in the next quarter pushes the coupon back up.
Tags: inflation, Inverse Floater
Can you provide more information on this? greets
I found your blog on google and read a few of your other posts. I just added you to my Google News Reader. Keep up the good work Look forward to reading more from you in the future.
Thanks; I post a blog every three weeks or so.
What exactly would you like to know more about? How inverse floaters work, or in which market scenarios they perform? Or…?
My name is Piter Jankovich. oOnly want to tell, that your blog is really cool
And want to ask you: is this blog your hobby?
P.S. Sorry for my bad english
Hi Piter, indeed, this is my hobby. Whenever something worthwhile comes up in the structured products field, I try to write it down and publish it on my blog.
I read a article under the same title some time ago, but this articles quality is much, much better. How you do this?
Well, I am a professional structurer with some experience. There are few of us who openly publish our ideas, so information about these products is quite difficult to find, I guess. I strive to make these relatively complex “things” more transparent. Thank you for the compliment, though.