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Leveraged floater

If a company issues a leveraged floater with principal of $10m that pays 1.5 times Libor, they purchase a fixed rate bond (with a principal 1.5 times the floater principal) to start the first leg of the hedge.

They purchase a bond with face value of $15M.

They receive $10M from selling the leveraged floater, but need to purchase a fixed rate bond for $15M. Is this right?

The book says they use the proceeds from the floater to buy the fixed rate bond, but they don’t mention the company has to come up with an extra $5m from somewhere.

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For exam purposes, the answer to your question is Yes.

Check this discussion:

cpk123 wrote:

This “twice” the notional principal has been a part of the curriculum in this section from a very long time back.

and each year the question is asked on the forum about this same thing.

(and there has been NO resolution).

I e-mailed CFA Institute about this last year.

Their answer was, to put it politely, unsatisfactory.

Ignore the numbers in this example: they’re wrong.

Focus on the main point: you can adjust the cash flows on an inverse floater with a swap.

Simplify the complicated side; don't complify the simplicated side.

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