An interest rate cap which is placed on a floating rate, requiring premium payment if a knock-out trigger rate is broken through. A knock-out premium trigger is set below prevailing market rates. The cap holder will not be required to pay a premium on reset dates in case the reference rate downwardly trades through or remains below the preset trigger (knock-out) rate. Nevertheless, the cap holder continues to enjoy full protection against potential rises in interest rates. Sometimes, a lock-out period is usually observed before the knock-out feature is activated. In this period, the cap holder is contractually obliged to pay premiums although he has not yet had access to the knock-out trigger.

Knock-out premium caps and knock-out caps differ categorically in the sense that in the former, the cap premium is meant to knock out, while it is the cap itself in the latter that is subject to a knock-out possibility.