What is an 'Interest Rate Floor'

An interest rate floor is an over-the-counter investment instrument that protects the floor buyer from losses resulting from a decrease in interest rates. The floor seller compensates the buyer with a payoff when the reference interest rate falls below the floor's strike rate.

BREAKING DOWN 'Interest Rate Floor'

For example, assume that an investor is securing a floating rate loan and is looking for protection against lost income that would arise if interest rates were to decline. Suppose the floor rate is 8% and that on a particular day, the rate on the investor's floating-rate loan of $1 million is 7%. The floor provides a payoff of $10,000 (($1 million *.08) - ($1 million*.07)).

RELATED TERMS
  1. Floor

    The lowest acceptable limit as restricted by controlling parties. ...
  2. Trading Floor

    The floor where trading activities are conducted. Trading floors ...
  3. Floor Broker (FB)

    An independent member of an exchange who is authorized to execute ...
  4. Floortion

    A type of option that gives the holder the right, but not the ...
  5. Globally Floored Contract

    A guarantee found in structured investment products that provides ...
  6. Telephone Booth

    A slang term referring to one of the many phone terminals on ...
Related Articles
  1. Managing Wealth

    Managing Interest Rate Risk

    Learn which tools you need to manage the risk that comes with changing rates.
  2. Trading

    Managing Interest Rate Risk

    Interest rate risk stems from the possibility that an interest-bearing asset’s value will change due to changing interest rates.
  3. Investing

    Are Clouds Finally Parting for Lumber Liquidators?

    After a year of uncertainty, Lumber Liquidators (NYSE: LL) finally has some clarity. The laminate flooring specialist reached a settlement with California's environmental regulators and agreed ...
  4. Investing

    Forces Behind Interest Rates

    Interest is a cost for one party, and income for another. Regardless of the perspective, interest rates are always changing.
  5. Investing

    How Negative Interest Rates Can Affect Banks' Bottom Lines

    Examine the impacts of low interest rates on banking industry profits and find out if negative interest rates will have a more extreme effect.
  6. Insights

    Forces Behind Interest Rates

    Get a deeper understanding of the importance of interest rates and what makes them change.
  7. Managing Wealth

    Buying a House Before an Interest Rate Hike

    Find out how a Fed rate hike would impact aspiring homebuyers, why rates increase, and whether now is the right time to buy a house.
  8. Personal Finance

    Understanding Term Loans

    A loan from a bank for a specific amount that has a specified repayment schedule and a floating interest rate.
  9. Investing

    Interest Rates Explained: Nominal, Real, Effective

    Interest rates are divided into subcategories. Smart investors look beyond the nominal or coupon rate of a bond or loan to see if it fits their objectives.
  10. Insights

    10 Countries With Lower Interest Rates Than the US

    Learn about the 10 countries with lower interest rates than the United States and how interest rates indicate a country's economic outlook.
RELATED FAQS
  1. Why are traders on the floor of the exchange?

    Before the advent of electronic trading platforms, the floor of the stock exchange was the location for market transactions ... Read Answer >>
  2. What does membership in the New York Stock Exchange entail, and why is it known as ...

    Owning a seat on the New York Stock Exchange (NYSE) enables a person to trade on the floor of the exchange, either as an ... Read Answer >>
  3. What is Ginzy trading?

    Ginzy trading is an order of different prices placed by a floor broker. It occurs when a floor broker attempts to avoid an ... Read Answer >>
  4. Which is better, a fixed or variable rate loan?

    A variable interest rate loan is a loan in which the interest rate charged on the outstanding balance varies as market interest ... Read Answer >>
  5. How can an investor reduce interest rate risk?

    Learn about the different ways investors can reduce interest rate risk. Locking in interest rates increases certainty for ... Read Answer >>
  6. What is the difference between real and nominal interest rates?

    Learn what nominal interest rates and real interest rates are, how real interest rate takes into account the inflation rate, ... Read Answer >>
Hot Definitions
  1. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  2. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  3. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
  4. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  5. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  6. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
Trading Center