Floor


A floor is the contractual agreement of an interest rate floor and protects the buyer against falling money market rates in exchange for paying an option premium. He also achieves a degree of planning certainty by agreeing a minimum interest rate and at the same time participating in rising money market rates.

  • Minimum interest rate = floor strike
  • Compensation payment = max (floor strike – reference rate, 0), i.e. the buyer receives a payment equal to the difference between the interest rate floor and the reference rate if the reference rate (e.g. 3M-Euribor) is below the interest rate floor on the roll-over day.

Example:

Underlying transaction: Investment in a floating rate note (FRN)

Floor

Interest rate hedge Floor with a minimum interest rate of 2%

Floor

 

Collar

Please click on the picture for a larger image

 

The floor agreement can be customized to meet your needs and those of the underlying transaction:

  • Interest Rate Floor (Strike Rate)
  • Notional amount and currency
  • Term
  • Reference rate
  • Amortization structure
  • Roll-Over Dates
  • In conjunction with purchasing a cap, the sale of a floor can be used to reduce the premium (=Collar).

In the event of early termination, the floor can be sold in the market at the current market value.