Types of frns, Financial Management

Assignment Help:

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.

 


Related Discussions:- Types of frns

What are the remedies for overtrading, What are the Remedies for overtradin...

What are the Remedies for overtrading Short-term solutions Speeding up collection from customers. Slowing down payment to suppliers. Maintaining lower inventory

Prepare general journal entries, On 1 July 2006, Goela Ltd was registered a...

On 1 July 2006, Goela Ltd was registered and offered 1 000 000 ordinary shares to the public at an issue price of $1.70, payable as follows: 50c on application (due 31 August)

Financial analysis, Task I am sure you are aware that the corporate annua...

Task I am sure you are aware that the corporate annual meeting is coming up soon. As part of the Treasurer''s presentation, I have been asked to propose a Special Capital Require

Prices and yields, Prices and Yields The face value of the government s...

Prices and Yields The face value of the government security is Rs.100 or Rs.1,000. Earlier, that is, before 1950s the government bonds were issued at a discount. There was no f

Weighted average cost of capital, Q. Weighted Average cost of Capital? ...

Q. Weighted Average cost of Capital? When the company capital structure is made from equity share capital , debenture and Preference share capital , then we calculated the comb

Baumol, To what extent does empirical evidence on corporate objectives supp...

To what extent does empirical evidence on corporate objectives support the predictions of Baumol’s “Sales Maximisation Hypothesis?”

Describe the merits and demerits of mutual funds, Question 1 Briefly expla...

Question 1 Briefly explain the important legislations that regulates the insurance sector Question 2 What do you mean by sales cycle? Briefly explain the different stages in

Historical differences in equity securities, Public Bourses The origin ...

Public Bourses The origin of this type of bourses can be found in the legislative work of Napoleon. These type of bourses are regulated by the government, brokers are appointed

Depreciation expense and investment in property plant, Use the excel spread...

Use the excel spreadsheet to project the net income for Winnebago from assumptions about key revenue & expense items.   Use the following assumptions to evaluate the projected net

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd