Municipal Inverse Floating Rate Securities
Cadmus Hicks, CFA, Ph.D. Managing Director Nuveen Investments
Municipal inverse floating rate securities are vehicles are used by institutional investors to increase, through the use of leverage, the tax-exempt income earned on municipal bonds. This chapter describes how inverse floating rate securities are structured and how their market value, duration, coupon, and yield are calculated.
Municipal inverse floating rate securities (inverse floaters
) are securities that pay a tax-exempt rate of interest that moves inversely with changes in short-term tax-exempt rates. Municipal inverse floating rate securities are created by a sponsor, which establishes a trust into which it deposits tax-exempt bonds. The trust then issues two classes of securities:
• Floating rate securities (FRS), which pay money market rates and which can be periodically tendered for redemption at par at the option of the holder (typically every week).
• Inverse floating rate securities that pay to the holder all income from the trust not needed to pay interest on the floating rate securities and expenses of the trust.
The interest rate on the FRS is set by an auction conducted by the remarketing agent. The remarketing agent is usually also responsible for providing liquidity for the FRS by promising to purchase any such securities that are not successfully remarketed.
The market value of the inverse floaters is equal to the market value of ...