An OTC interest rate derivative, or simply a contract on an interest rate whereby the seller (or the writer) pays the buyer, at periodic payment dates, the negative difference between the market interest rate (the reference interest rate) and the agreed strike price (the floor). The floor, in other words, is the minimum interest rate that may be effected on, or affixed to, a contract. For example, a lender may buy an interest rate floor stipulating that the interest rate should not go below 4% even if market rates necessitate lower levels. This way, an interest rate floor reduces the risk to lenders receiving the interest payments and guarantees a minimum rate for their loaned money.
November 16, 2023
