An interest rate swap that is subject to interest rate cap in which the fixed-rate payer pays the at-market rate and receives a floating rate (LIBOR) in addition to a specified margin amount conditioned on the floating rate not breaking out above a trigger point (typically, a current implied forward rate). As such, if the floating rate breaches the trigger level, then the fixed rate payer will receive the at-market rate, while still paying the same at-market rate. In this case, the swap effectively ceases to exist monetarily for a respective period (i.e., a period during which the trigger is breached). Otherwise, the fixed rate payer will be able to fix payments at below-market rates. Functionally, by entering a performance swap, the fixed rate payer will simultaneously take two positions; a long position in an interest rate swap a short position in a binary call option on the floating rate.
December 21, 2024
