An interest rate cap whose existence or activation depends on a floating rate or index crossing a certain barrier or threshold level. Generally, barrier caps come in different types: knock-in cap, knock-out cap, one-time barrier cap, and sticky barrier cap. The barrier rate can be higher or lower than the cap rate, depending on an investor’s views on interest rate. Insofar as the existence of barrier caps is just a matter of probability, not surety, premiums on barrier caps usually exceed premiums on ordinary caps.

For example, an investor wants to hedge against interest rates climbing above 8%. He buys a two-year knock-out, sticky barrier cap on a floating reference index at 8%. The barrier will be set, for example, at 6.5%. In this case, we assume the investor contemplates that if rates could touch the barrier in the two year horizon, then it would be relatively unlikely that rates rebound to 8%. Of course, once the cap is knocked-out, the investor need reconsider his outlook, readjusting whereby his hedging strategy.