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

Convertible and non-convertible bonds, Bonds can also be classified i...

Bonds can also be classified into convertible and non-convertible depending upon whether they carry a conversion feature or not. Convertible bonds are the ones which ca

Initial public offering (ipo), The process by which an organization increas...

The process by which an organization increase money by issuing equity and gets listed on a public stock exchange.

Advantages and the disadvantages of a new stock issue, What are the advanta...

What are the advantages and the disadvantages of a new stock issue? A new stock issue increases funds and decreases the riskiness of the firm.  It as well tends to send a negat

How & why does working capital affect incremental cash flow, How and why do...

How and why does working capital affect the incremental cash flow estimation for a proposed large capital budgeting project?  Explain. Several large projects require additional

Sustainable growth rate, You are given the following information for Clapto...

You are given the following information for Clapton Guitars, Inc. Profit margin 6.3% Total Asset turnover 1.6 Total debt ratio 0.44 Payout ratio 35% Calculat

What are the benefits of traditional approach, What are the benefits of Tra...

What are the benefits of Traditional approach Traditional approach had a very narrow perception and was devoid of an integrated conceptual and analytical framework. It had pre

Explain the random walk model for exchange rate forecasting, Explain the ra...

Explain the random walk model for exchange rate forecasting. Can it be consistent along with the technical analysis? Answer:  The random walk model assumes that the current excha

Price-yield relationship in bonds, Typically in a bond, we find...

Typically in a bond, we find an inverse relation between the price and the required yield. We know that the price of the bond is the present val

Forecasting yield volatility, There are several methods available to ...

There are several methods available to forecast yield volatility. But before that, let us look into the calculation of forecasted standard deviation. Assume th

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