PPT Slide

Consider a 10-year 7.5% coupon semi-annual pay bond. $100 million

of the bond is used as a collateral to create a floater with a par value

of $50 million and an inverse floater with a par value of $50 million.

Floater coupon rate: reference rate + 1%

Inverse floater coupon rate: 14% - reference rate

The weighted average of the coupon rate of the combination of the

two bonds is

0.5(reference rate + 1%) + 0.5(14% - reference rate) = 7.5%.

If a floor is imposed on the inverse, then correspondingly a cap is

imposed on the floater:

inverse’s price = collateral’s price - floater’s price