Interest Rate Floor

AAA

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.

INVESTOPEDIA EXPLAINS '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. Floating-Rate Note - FRN

    A note with a variable interest rate. The interest rate is usually ...
  2. Over-The-Counter Market

    A decentralized market, without a central physical location, ...
  3. Floortion

    A type of option that gives the holder the right, but not the ...
  4. Interest Rate Options

    An investment tool whose payoff depends on the future level of ...
  5. Interest Rate Ceiling

    The maximum interest rate that a financial institution can charge ...
  6. Interest Rate

    The amount charged, expressed as a percentage of principal, by ...
RELATED FAQS
  1. How do futures contracts roll over?

    Traders roll over futures contracts to switch from the front month contract that is close to expiration to another contract ... Read Full Answer >>
  2. Why do companies enter into futures contracts?

    Different types of companies may enter into futures contracts for different purposes. The most common reason is to hedge ... Read Full Answer >>
  3. What does a futures contract cost?

    The value of a futures contract is derived from the cash value of the underlying asset. While a futures contract may have ... Read Full Answer >>
  4. How can I hedge my portfolio to protect from a decline in the food and beverage sector?

    The food and beverage sector exhibits greater volatility than the broader market and tends to suffer larger-than-average ... Read Full Answer >>
  5. Why are the term structure of interest rates indicative of future interest rates?

    The term structure of interest rates is influenced by the expectations for future yields and interest rate risk according ... Read Full Answer >>
  6. What techniques are most useful for hedging exposure to the insurance sector?

    Investing style determines the best hedging techniques for the insurance sector. This sector comprises three segments, two ... Read Full Answer >>
Related Articles
  1. Economics

    Forces Behind Interest Rates

    Get a deeper understanding of the importance of interest rates and what makes them change.
  2. Investing Basics

    What Investors Should Know About Interest Rates

    Understanding interest rates helps you answer the fundamental question of where to put your money.
  3. Investing Basics

    Understanding Total Return Swaps

    A total return swap is a contract in which a payer and receiver exchange the credit risk and market risk of an underlying asset.
  4. Investing Basics

    Explaining Absolute Return

    Absolute return refers to an asset’s total return over a set period of time. It’s usually applied to stocks, mutual funds or hedge funds.
  5. Economics

    Why The Dollar’s Strength Can Continue

    Overall, the U.S. dollar has rallied this year, with the Dollar Index (DXY) now up by roughly 8 percent year-to-date, but the gain hasn’t been steady.
  6. Investing

    Is It Time To Buy Commodities?

    Despite the news, the Athens Stock Exchange is down less than 5 percent year-to-date, while the Shanghai Composite remains up more than 10 percent.
  7. Mutual Funds & ETFs

    5 Disadvantages of Mutual Funds Compared to ETFs

    In the mutual funds vs. exchange-traded funds debate, ETFs have some clear advantages.
  8. Mutual Funds & ETFs

    ETF Analysis: PowerShares DB US Dollar

    Discover how an ETF can be used to bet on multiple different currency futures contracts with the PowerShares DB Dollar Index Bullish Fund (UUP).
  9. Options & Futures

    Understanding Bull Spread Option Strategies

    Bull spread option strategies, such as a bull call spread strategy, are hedging strategies for traders to take a bullish view while reducing risk.
  10. Investing

    Some Overseas Markets May Prove More Resilient

    Though global markets sold off and have continued to slip in recent days, stocks in Europe and Japan are still faring better than their U.S. counterparts.

You May Also Like

Hot Definitions
  1. Bogey

    A buzzword that refers to a benchmark used to evaluate a fund's performance. The benchmark is an index that reflects the ...
  2. Xetra

    An all-electronic trading system based in Frankfurt, Germany. Launched in 1997 and operated by the Deutsche Börse, the Xetra ...
  3. Nuncupative Will

    A verbal will that must have two witnesses and can only deal with the distribution of personal property. A nuncupative will ...
  4. OsMA

    An abbreviation for Oscillator - Moving Average. OsMA is used in technical analysis to represent the variance between an ...
  5. Investopedia

    One of the best-known sources of financial information on the internet. Investopedia is a resource for investors, consumers ...
  6. Unfair Claims Practice

    The improper avoidance of a claim by an insurer or an attempt to reduce the size of the claim. By engaging in unfair claims ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!