- CFA Exams
- CFA Level I Exam
- Study Session 14. Fixed Income (1)
- Reading 42. Fixed-Income Securities: Defining Elements
- Subject 4. Structure of a Bond's Cash Flows

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**CFA Practice Question**

An inverse-floater has coupon rate = 5% + Maximum [(0.60 x (15% - r)) or 0], where r is the six-month LIBOR rate.

B. The floor coupon rate is 5% and occurs when 6-month r >= 15%.

C. The cap coupon rate is 14% and occurs when 6-month r >= 15%.

A. The cap coupon rate is 20% and occurs when 6-month r = 0%.

B. The floor coupon rate is 5% and occurs when 6-month r >= 15%.

C. The cap coupon rate is 14% and occurs when 6-month r >= 15%.

Correct Answer: B

For all values of six-month LIBOR greater than 15%, coupon rate = 5% + Maximum[(0.60 x (15% - r)) or 0] = 5%.

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**User Contributed Comments**
6

User |
Comment |
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finances |
I don't understand. |

krisna |
When r=15%, the inverse floater's rate = 5% + 0. Try the formula again, when r >=15% .. the inverse floater's formula will produce rate <5%. Thus, the floor coupon rate is 5%, holds true when 6-month r >= 15%. B is correct. |

michlam14 |
when we are dealing with an inverse floater, is the max (cap) and the min (floor) the opposite of a normal floater, ie the floor becomes the cap and the cap becomes the floor? |

Emily1119 |
Sorry i still can't understand: How can we know it is cap or floor? |

johntan1979 |
Cap: minimize r ==> r=0 Floor: maximize r ==> r>=15 |

jonan203 |
emily1119: if you can't see the cap or floor by looking at the equation, graph it in a ti-85 with this formula y = max{.60(.15 - x, 0)} + .05 |