Leverage and Valuation
Additional valuation of an inverse floater can be determined by looking at the security's coupon leverage. To illustrate, suppose the creator of the floater and inverse floater divides the underlying collateral up into 100 bonds, 20 inverse an 80 floater bonds. The leverage in this structure is 4:1 of floater to inverse bonds. As such the following relationship must hold:
Based on this formula and value of the collateral, it can not be assumed that a decrease in the reference rate will automatically translate into a gain for the inverse floater. Such scenarios can be attributed to changes in the overall market and the yield curve that negatively impact the collateral's value.
Read more about this topic: Inverse Floating Rate Note