Dula Indexed Floater Bonds

A DUAL-INDEXED FLOATER is a floating rate Agency bond whose coupon is reset using a COMBINATION of two indexes, one subtracted from the other, and then adding some number of basis points. One is a long term index the other a short term index.

Example: coupon=(10 year Treasury Rate MINUS 1 month Libor)+250 Basis Points If the 10 year Treasury is 6% and 1 month Libor is 3% coupon= (6%-3%) + 2.50% = 5.50%

The key to a DUAL-INDEX floater is the basis point spread between the two indexes. In our above example, the difference between long term rates (the 10 year Treasury Rate) and short term rates (the 1 month Libor) is 3%. If the yield curve “flattens” and this spread “tightens” then the coupon on the floater will go down:

Example: 10 year CMT goes up to 7% and 1 month LIBOR goes up to 4.50% (long term rates up 100 Bps, and short term rates up 150 Bps) coupon = (7%-4.50%)+2.50%=5%

In this scenario, the general level of interest rates has gone up but the Dual-Indexed Floater’s coupon has gone down, because the yield curve has flattened. If the yield curve becomes more steep (the spread between the two indexes becomes greater), then the coupon on a Dual-Indexed Floater will go up. In effect, this floater’s coupon is a reflection of “steepness” of the yield curve more than a reflection of the general direction of interest rates. For this reason, DUAL-INDEXED Floaters are sometimes called Yield Curve Anticipation Notes (“YCANs”).