Interest Rate Cap An interest rate cap is actually a series of European interest call options called caplets , with a particular interest rate, each of which expire on the date the floating loan rate will be reset. At each interest payment date the holder decides whether to exercise or let that particular option expire.

In an interest rate cap, the seller agrees to compensate the buyer for the amount by which an underlying short-term rate exceeds a specified rate on a series of dates during the life of the contract. I nterest rate caps are used often by borrowers in order to hedge against floating rate risk.

Interest Rate Floor Floors are similar to caps in that they consist of a series of European interest put options called caplets with a particular interest rate, each of which expire on the date the floating loan rate will be reset.

Managing Interest Rate Risk

In an interest rate floor, the seller agrees to compensate the buyer for a rate falling below the specified rate during the contract period. A collar is a combination of a long short cap and short long floor, struck at different rates.

The difference occurs in that on each date the writer pays the holder if the reference rate drops below the floor.

Derivatives: Interest rate Cap,Floor and collars | AnalystForum

Lenders often use this method to hedge against falling interest rates. Dictionary Term Of The Day. A measure of what it costs an investment company to operate a mutual fund.

Interest Rate Caps and Floors | Derivatives Risk Management Software & Pricing Analytics | FINCAD

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The cash paid to the holder is as follows: Learn which tools you need to manage the risk that comes with changing rates.

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