Capped and Inverse Floaters
Two variations on a floating-rate bond — one that stops paying more once rates rise past a ceiling, and one whose coupon actually falls when rates rise instead of moving with them.
Prerequisites: Floating Rate Notes
A plain floating-rate note pays a coupon that resets with a reference rate — say, SOFR plus a spread — so its price stays close to par as rates move. Two structured variants change that relationship on purpose.
A capped floater pays the floating coupon only up to a stated maximum. Once the reference rate rises past the cap, the coupon stops increasing, which is effectively the issuer buying a cap option from the investor (and paying for it with a slightly richer spread while rates are low).
An inverse floater goes further: its coupon is set as a fixed rate minus a multiple of the reference rate, so the coupon falls as rates rise and rises as rates fall — the opposite of what a normal floater does.
A capped floater caps upside coupon growth as rates rise; an inverse floater's coupon moves opposite to rates entirely, making it behave like a leveraged bet on rates falling rather than a rate-neutral instrument.
Worked example
An inverse floater might be structured as coupon = 8% − 2 × SOFR. If SOFR is 2%, the coupon is 8% − 4% = 4%. If SOFR rises to 3%, the coupon falls to 8% − 6% = 2%. If SOFR rises further to 4%, the coupon hits zero. This is why inverse floaters have very high effective duration — much higher than a normal fixed bond of the same maturity — since their coupon moves in the same direction a bond's price would move on a rate change, doubling the sensitivity.
These structures are typically sold to investors with a specific view on rates, or paired together so an issuer can fund itself at a lower blended cost across both tranches.
Related concepts
Practice in interviews
Further reading
- Fabozzi, F., 'The Handbook of Fixed Income Securities' (structured floaters chapter)