A moving average cap is a cap which pays off the maximum of reference rate averages associated with several periods (window periods) within the lifetime of the contract. At maturity, the holder gets only one payment, being the highest moving average (MA) over the entire life of the cap. The following example illustrates how a moving average cap works:

Suppose today is 01 March 2015 and that a moving average cap has the following features:

Notional amount: $5 million.

Reference rate: 3-month LIBOR.

Strike rate: 5.90%

Contract date: 01 May 2015

Cap maturity: 1 year.

Day-count convention: Actual/360

Window period: 6 months.

3-month LIBOR rates over the cap maturity: 6.50%, 5.80%, 5.60%, and 5.75%.

The average rates for the window periods (moving averages) are:

First window average rate= (6.50% + 5.80%)/2 = 6.15%

Second window average rate= (5.80% + 5.60%)/ 2 = 5.70%

Third window average rate= (5.60% + 5.75%)/ 2 = 5.675%

Therefore, the cap payoff is:

Payoff_cap= notional amount × Max [0; highest MA- strike rate%]

Payoff_cap=$5 million × Max [0; 6.15% – 5.90%] = $12,500.