Interest-rate cap / floor
Definition · Level 10 · Derivatives pricing
Keep reading with Tradecraft
Without an account, you can read three definitions every 30 days. Tradecraft explains all 738 terms and strategies, with the lessons that teach them, flashcards that come back before you forget, quizzes and a payoff lab.
Strips of options on a floating rate: the first pays when fixings exceed the strike (a borrower’s hedge), the second when they fall below it (a lender’s hedge).
Example
Buy a 3% cap on a EURIBOR loan: pay no more than 3% plus margin.
Where Tradecraft teaches it
Level 10 · Derivatives pricing, in the lesson “Rates derivatives: discount factors, FRAs & swaps”: Discount factors, forward rates, FRAs, swaps, OIS benchmarks, caps, floors, swaptions and swap spreads.
Related terms
- Discount factorToday’s value of 1 paid at date T: 1/(1 + z)^T or e^(−zT) — the price of a zero-coupon bond per unit of face.
- Forward rateRate for a future period locked in by today’s curve: (1 + z2)² = (1 + z1)(1 + f).
- FRA (forward rate agreement)Contract fixing the rate on a future period — a 3×6 locks the 3-month rate starting in 3 months — cash-settled against the fixing.
- OIS (overnight index swap)Swap of a fixed rate against a compounded overnight rate — €STR, SOFR, SONIA.
- Par swap rateFixed rate that makes a new swap worth zero; with a single curve, (1 − DFn) ÷ Σ τ·DFi.
- Payer swapInterest rate swap in which you pay fixed and receive floating: gains when rates rise, like being short a bond.