Types of frns, Financial Management

Types of FRNs

In an era of innovations, while changing needs and preferences of the investors trigger introduction of newer FRNs, the borrowers' funding specifications also necessitate the sprouting of new varieties of FRNs. Some of the important varieties are listed hereunder:

  • Flip-flop FRNs
  • Mismatch FRNs
  • Mini-max FRNs
  • Capped FRNs
  • Structured FRNs
  • Perpetual FRNs
  • Deleveraged FRNs
  • Inverse FRNs.

Flip-Flop FRNs

The World Bank came out with an issue of FRNs in 1985, with a spread of 50 basis points over the three-month US Treasury Rate and a perpetual life. It also provided the note holder an option of converting the FRN into a three month flat yield at the end of every sixth months. The investor could again go back to floating rate with perpetual maturity if he desires so.

Mismatch FRNs

These are also called rolling rate FRNs.

Mini-Max FRNs

These FRNs consist of minimum and maximum coupons. Investors benefit in terms of high spread (over the LIBOR), but have to agree to a minimum rate as well as a maximum rate on their notes, the differential between the two being very small. These are also referred to as Collared FRNs. For example, a bond with 5-year maturity and coupon interest payable six monthly at LIBOR - 0.50% subject to a cap of 8.25% and a floor of 5.5%.

Capped FRNs

Under capping arrangements, the FRNs issued are pegged to an interest rate cap. This means that the issuer need not pay interest beyond the ceiling level even if the LIBOR shoots up to more than that level. In order to protect the interests of the investors and make the bond attractive, normally higher margins are offered on such FRNs.

Structured FRNs (Variable Rate Notes)

This is one of the latest innovations which is issued for longer terms (sometimes perpetual also) with variable interest spreads with margins over LIBOR going up for later maturities. Margins for the subsequent dates in this regard are fixed either by auctioning or through a mutual agreement.

Perpetual FRNs

These are also called irredeemable or unrated FRNs and are akin to a form of capital.

Deleveraged FRNs

The reference rate is adopted as a percentage of the value of reference index. For example, the coupon will be determined as 75% of LIBOR + 0.7%. It may be noted that the reference rate is not taken as the full value of LIBOR.

Inverse Floating Rates

The coupon rate increases when the LIBOR rate decreases and vice versa. This benefits the investors when the rate of interest in the market is in the declining trend.

Risks Associated with FRNs

Basically there are two risks associated with FRNs. One is the interest rate risk and other default risk.

Interest Rate Risk

Normally short-term interest rates have higher volatility than long-term interest rates. So an FRN holder may hedge against such risk by taking positions in Eurodollar futures contracts or interest rate swaps. The risk in institutions holding a portfolio of FRNs with different reset dates, is very similar to a portfolio of short-term paper issued by the respective companies with maturity dates coinciding with various reset dates.

 

Posted Date: 9/10/2012 8:26:02 AM | Location : United States







Related Discussions:- Types of frns, Assignment Help, Ask Question on Types of frns, Get Answer, Expert's Help, Types of frns Discussions

Write discussion on Types of frns
Your posts are moderated
Related Questions
We can measure the convexity with the help of following formula:                                                                              ...Eq. (4) Where,          Δ

Determine in brief about Venture capitalists Venture capitalists are organisations which take on risky business ventures. They provide finance for and generally require a high

Duration and Convexity of MBS A graph decpicting the price of the security under study and the interest rates helps in assessing the duratio

What are the main classes of institutions that issue bonds in the USA? There are three major classes of institutions which issue bonds in the USA: national governments, local g

Takeover, Inc. is a Delaware corporation whose only stated purpose is to acquire companies.  It has virtually no assets and no employees other than the original founders who contri


Question 1 Describe the types of investment decisions Question 2 List the main features of ordinary shares Question 3 List the assumptions of Walter's dividend model. Ex

that the business has far fewer linens than it needs, so he makes a major linen purchase on open account. Which of the following terms refers to the fact that partners Ma and Runni

OTC refers to financial securities whose sale and purchase are not conducted over a stock exchange.

State the term- Dealing with general risk Part  of  the  strategic  decision  making  process  is  to  analyse  all  risk  factors  involved  with pursuing a specific course of