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Dear Sir
I am self-studying and reading the bpp study note. I don’t understand: “a loan that pays an inverse floating interest rate” does not pass the contractual cash flow test (page 197). Could you explain for me more details the reason?
Thanks in advance
Hi,
A loan of this type is where the floating rate of interest is based on a fixed rate LESS the variable rate (is it 8% less LIBOR in the notes?). This means that if the LIBOR rate goes up then the overall rate of interest on the loan goes down (hence the term inverse).
As the LIBOR rate could potentially increase to a level that means no interest on the loan is paid, so if it rose to 8% using the figures in the notes, then there would be no contractual cash flows.
Hope this helps.
Thanks
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