Interest Rate Floor

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DEFINITION of 'Interest Rate Floor'

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)).

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