A floating-rate note (FRN) in which coupon rates (coupon reset rates) are subject to an upper limit. Like standard FRNs, capped FRNs pay a normal floating rate note coupon up to a specified maximum rate. If rates exceed that limit, the coupon is fixed at the capped rate. For example, a capped FRN may have a maximum rate of 7% placed on its coupon reset rates which are currently in the range of 5-6%. Once the market rate rises above 7%, the rate is automatically fixed at 7%. Later on, if the market rate drops below 7% to 6.5%, for example, the coupon reset rate readjusts to 6.5%.
In terms of composition, a capped FRN is a combination of an FRN with an interest rate cap. However, mathematically, the value of a capped FRN is equal to the value of an uncapped FRN minus the value of a cap:
Capped FRN = uncapped FRN – cap
The capped FRN is also known as a capped floater.
