DEFINITION of ‘Leveraged Floater’
A leveraged floater, also known as a leveraged floating-rate note, or a super floater, is a floating rate note, which has a leverage factor λ, that is greater than one, and a spread with a variable coupon rate, or yield. They are tied to widely quoted benchmark interest rate, such as the fed funds rate, the treasury rate, LIBOR or EURIBOR, and tend to perform well when interest rates are rising.
BREAKING DOWN ‘Leveraged Floater’
A floater, or floating rate note is a bond with a variable interest rate. For example, a note may have an interest rate of “EURIBOR + 1%” and pay whatever the EURIBOR rate happens to be at the time plus 1%. Unlike their fixed-rate counterparts, whose prices tend to drop when rates rise, floating-rate investments yield more income.
Leveraged floaters allow investors to receive an above-market initial yield, while linking subsequent coupon adjustments to a given point on the yield curve. The coupon rate increases or decreases by an amount greater than the benchmark rate or index it is associated with.
Leveraged floaters make sense when the Fed is hiking rates, and short-term interest rates are rising, as their prices tend to be stable – they have durations close to zero – and their coupons should move higher as short-term rates rise. However, although their prices remain relatively stable when interest rates are rising, even investment grade leveraged floating rate notes can be risky. Besides default risk, nearly half of floaters are issued by financial institutions, so there is a risk of price declines during periods of financial stress, as was seen during the 2008 global financial crisis and the European debt crisis in 2011.
The Formula for Coupon Rate on a Leveraged Floater
Coupon Rate on a Leveraged Floater = λ (Benchmark Interest Rate) + Spread
where λ > 1
This is the same formula used to find the coupon rate of a deleveraged floater (only the leverage factor distinguishes one from the other). So, assuming the EURIBOR benchmark rate is 0.2%, a leverage factor of 1.3 and a margin of 1%, the coupon rate would be 1.26% (0.2% x 1.3 + 1%).