what are the practical usage of these two instruments besides capturing some mispricing spread?
generating commision revenue for IB?
You can use an inverse floater if you are receiving a floating rate and paying a fixed to hedge the exposure, right? I still have to review that section. If I am long a floating rate security and Interest Rates decrease, I pay less If I am long a floating rate security and Interest Rates Increase, I pay more If I am short a floating rate security and Interest Rates decrease, I receive less If I am short a floating rate security adn Interest Rates Increase, I receive more. So wouldn’t an inverse Floater, just be the inverse of the above???
Of course CSK is right, but another even more sinister reason is that all these structured notes allow someone to get past investment restrictions. Both leveraged floaters and inverse floaters have been abused by money market fund managers. Usually money marekt funds have exceptions for floating rate notes (the intention being that a money market fund ought to be able to buy, say, a three year floating rate note instead of constantly buying 90-day notes from the same issuer). Often they can use these exceptions to make interest rate bets using mortgage derivatives. There’s a pretty big list of funds that have gotten in trouble that way.
bigwilly Wrote: ------------------------------------------------------- > You can use an inverse floater if you are > receiving a floating rate and paying a fixed to > hedge the exposure, right? I still have to review > that section. > Yeah, but is there really anybody out there truly “hedging” by using a complex mortgage derivative? There are much easier ways to hedge falling interest rates (like go long a bond future).
True, but you “could” if you wanted to just like you “could” jump off a bridge but most people choose not to 
rand0m Wrote: ------------------------------------------------------- > what are the practical usage of these two > instruments besides capturing some mispricing > spread? BTW, it is part of an LOS? Just curious, since I did not find any LOS that referred to this section within Reading 40. Thanks,
bigwilly Wrote: ------------------------------------------------------- > True, but you “could” if you wanted to just like > you “could” jump off a bridge but most people > choose not to And if the question asked “What is the purpose of the Tappan Zee bridge?”, a fair answer might be “To facilitate suicides of people who commute from Jersey to Connecticut”. It wouldn’t be my answer, but it would be hard to mark wrong.
No I would mark that as Correct! Got to love the signs they put up on the bridge now…haha.
I would like to steal one and put over my bed.
haha…that would be classic. Or just put it at your trading desk when times get tough 
abacus Wrote: > BTW, it is part of an LOS? Just curious, since I > did not find any LOS that referred to this section > within Reading 40. Thanks, i have the same problem as yours. how are these related to los. the LOS asks to use swaps to manage risk. both floaters were cited in cfai book under this section, r40. i would assume these structured notes would help to mitigate risks of some kind. but, the examples given only showed dealer’s profits. net of leverage floater: (k) * (FP) (r - R) net of inverse floater: (FP) * (r + R - b) (where R is swap rate, r is a fixed bond rate, a fixed rate used to measure the difference from libor and it’s the difference (b - libor) that dealer of inverse floater promised to pay, FP is nominal amount, k is a leverage ratio.) looking at both nets, it seems to me that dealers spoted some mispricing and then act on them by issuing these structured notes to capture the spreads. nice and smart, but, these people don’t seem to have any risk exposure to start with.
Are these things actually used? I assumed that inverse floaters were introduced by some academic that wanted to say “how would you solve this one.” For practical purposes, I would think the cash flows could be replicated by some combination of futures and standard interest rate swaps, and some options if you wanted to replicate a floor.
Except if you’re a money market fund you can’t go trade futures contracts. You can buy a 3-year floating rate loan which is collateralized by FNMA paper and the interest rate is floating as 10* arcsin(LIBOR * integrated corn price /Pi^2). People create this stuff because someone can buy it (in truth I think most money market funds have stomped on this stuff).