…please forgive me if this has been posted. 1, Leveraged floater: To the issuer, paying m x LIBOR rate on notional principal NP is the same as “paying LIBOR rate on m x NP”, where m>1. As a floater issuer, the company can a) enter a swap as a fixed rate payer(fixed rate=FS). — doesn’t like to pay floating-rate. b) buy a fixed-rate bond with coupon ci; — to invest with the proceeds. In case of leverage floater, just use (m x NP) as the notional principal. So, the net cash flow is: (ci-FS)*(m x NP) 2, Inverse floater: To the issuer, paying (b-LIBOR) rate on notional principal NP is the same as “paying fixed-rate b and receiving LIBOR on NP”. To receive the fixed-rate, the issuer can a) enter a swap as a fixed rate receiver(fixed rate=FS). b) buy a fixed-rate bond with coupon ci; Now the net cash flow is: (ci+FS-b)*NP ================================= To keep it simple, I assume the coupon is paid annually. The notation of (ci, FS) is from the book…A diagram also helps…note that: 1) the issuer usually likes the fixed-rate: pay or receive; 2) the issuer buys a fixed-rate bond, which will “lock” the rates. (taking risk as well).
- In a leverage floater, the issuer(borrower) shall pay the principal of (m x NP) at the end.
Correction: 3) In a leverage floater, the issuer(borrower) shall pay the principal of (NP) at the end.