Capped and Inverse Floaters

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.

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.