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

Introduction of just-in-time inventory management, Q. Introduction of just-...

Q. Introduction of just-in-time inventory management? It has already been observe that a reduction in inventory due to the introduction of just-in-time inventory management ca

Examine the examples of political risk within countries, Examine the Exampl...

Examine the Examples of political risk within countries Outbreak of national war, unrest, civil war or riot. Nationalisation of industriesfor example confiscation of as

Define swap broker, Define Swap Broker A swap broker arranges a swap am...

Define Swap Broker A swap broker arranges a swap among two counterparties for a fee with no taking a risk position in the swap.

Determine the limitations of trade receivable day ratio, Determine the Limi...

Determine the Limitations of trade receivable day's ratio Year-end trade receivables may not be representative of the year. Credit sales are VAT exclusive in the Incom

Structure and participation of hedge funds, Structure and Participation of ...

Structure and Participation of Hedge Funds: The typical structure for a Hedge Fund is to facilitate the tax concerns of investors and fund managers. Basically, there are two or

Historical versus implied volatility, There are two ways to estimate ...

There are two ways to estimate yield volatility - historical volatility and implied volatility. Thus far we have discussed how to calculate volatility by estimati

Three-phase source voltages and phase sequence, Q. Three-phase source volta...

Q. Three-phase source voltages and phase sequence? The elementary three-phase, two-pole generator shown in Figure has three identical stator coils (aa, bb, and cc) of one or

Liabilities, Liabilities The company must take into account the nature ...

Liabilities The company must take into account the nature of its liabilities as well as its solvency position. Cash Flows: Besides the investment yields, money flows as paid

Buy down loans, The buy down loan is similar to the PAM; however, it ...

The buy down loan is similar to the PAM; however, it is the seller of the property and not the buyer/borrower who places cash in a segregated account so that additional

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