Inverse floaters are back

Inverse floaters have made a come back after a gap of two years. The need for higher returns by mutual funds and a slight change in the perception about interest rates have brought about a two-way view in the market.

Inverse floaters are bonds where the interest rate is linked to a negative spread over the fixed coupon rate. The spread is usually few percentage points over the Mumbai interbank bid offer rate (Mibor) rate. Mibor is the benchmark for domestic interest rates based on government securities.

Most non-banking finance companies (NBFCs) have issued inverse floaters to raise funds aggregating around Rs 400-500 crore in order to bring down the cost of raising funds. NBFCs such as Mahindra and Mahindra Finance, Rabo India Finance, Cholamandalam Finance and Sundaram Finance are raising funds using inverse floaters. An inverse floater, issued last time, was by Grasim Industries in 2002.

The difference between floaters issued today and those issued in 2002 is that earlier the benchmark used to be either Mibor or Mifor (Mumbai implied bid offer rate), a derived rate from the foreign exchange forward rates.

"Credit offtake in the current financial year is not expected to be as robust as during the last year. Government has reiterated a lower than targeted borrowing programme. This has resulted in a renewed interest among banks for government securities and investment as a whole," said a bank dealer.

Except for the impact of oil prices and the effect on inflation, there are no major negatives for the market, the dealer added. This is in stark deviation from the earlier view that interest rates can only rise.

Should interest rates go up, corporates end up paying less as the coupon will be a few percentage point lower than the original coupon rate.

However, investors, usually mutual funds, loaded with huge subscriptions under liquid schemes, are looking for higher returns, said a corporate issuer.

"We expect interest rates to stabilise around these levels if not soften. This will translate into higher returns compared with market rates," said a fund manager on condition of anonymity.

Two years later...

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• Inverse floaters are bonds where the interest rate is linked to a negative spread over the fixed coupon rate
• The spread is usually a few percentage points over the Mumbai interbank bid offer rate, the benchmark for domestic interest rates that is based on government securities
• Non-banking finance companies have issued inverse floaters to raise funds aggregating around Rs 500 crore as a cost-saving move.