Forex Investment and Currency Trading

Description

An Inverse Floater Deposit (or Inverse Floater) is a structured deposit that pays a coupon that is inversely linked to a floating interest rate index. The initial coupon is usually much higher than a comparable vanilla deposit. Typically, if the index goes up by 1% then, depending on the leverage of the Inverse Floater, the coupon received will go down by 1% (no leverage), 2% (twice leveraged), 3% (three times leverages) etc… The coupon is typically expressed as:

Coupon = Max (X% - Leverage x Index, Min Coupon%)

Inverse Floaters are typically structured as principal protected – the minimum coupon will therefore not be negative.

Application

An Inverse Floater enables coupon enhancement via directional exposure on interest rates: in the example below, the company seeks a deposit with a minimum coupon of 0.75% and an enhanced return if rates increase less than implied by the market:

• The minimum coupon is 5bp more than the 1 year fixed deposit rate available (0.70%). For the subsequent years the company will receive an enhanced return (maximum 2.00%) if 3 month JPY LIBOR fixing in arrears is less than the current implied forward rates.
• The breakeven 3 month JPY LIBOR rate is 1.00% (2.00% - 1.00%), when compared with the 3 year JPY Fixed Deposit rate. This will result in a yield enhancement of 5bp above the 1 year deposit rate for the first year.
• The inverse floater comprises (i) a Swap, where the company receive 2.00% vs 3 month JPY LIBOR in arrears, (ii) an In Arrears Floor on 3 month JPY Libor, with a strike of 0.75% bought by the company and (iii) a deposit where the company is essentially giving up the vanilla funding rate in return for the structured coupon.
• As such, the inverse floater will offer more attractive terms when (i) the yield curve is steep and/or (ii) the implied volatilities for the Floor are low.

Variations

• Common variants include (a) “Quanto” payment (i.e. using a floating rate from a different currency), (b) fixing in advance instead of in arrears, (c) introducing leverage factors on the floating rate, or (d) using a CMS-based coupon instead of LIBOR.
• To enhance the terms of the structure, the Inverse Floater can be made “Callable” or “Multicallable”, whereby the company sells the right to terminate the structure at a single predetermined date (e.g. after one year) or at a series of predetermined dates (e.g. semiannually) respectively.