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CFA Level I · CFA Level I Exam · Fixed-Income Cash Flows and Types

An inverse floating-rate note pays a coupon of 9% minus the reference rate, with a floor of 0%. The reference rate is 3% at one reset and 10% at the next. The coupons for those two periods, on an annual basis, are most likely:

The coupons are 6% and 0%. At a 3% reference rate the coupon is 9% minus 3%, or 6%. At a 10% reference rate the formula gives negative 1%, but the 0% floor lifts it to zero, so no interest is paid.

  1. A0% and 6%
  2. B3% and 0%
  3. C6% and 0%Correct

Explanation

Coupon at 3% reference = 9% − 3% = 6%. At 10%, 9% − 10% = −1%, but the floor sets it to 0%. The 0% and 6% option reverses the order, and 3% and 0% subtracts incorrectly at the first reset.

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