Interest Rate Floor

The interest rate floor is a derivative financial instrument – an interest rate option or a series of interest rate options protecting their buyer against a fall in a certain reference interest rate index. The buyer of the option receives payment from the seller in cases where the reference interest rate is lower than a predetermined level of protection (execution price). The buyer of the interest rate floor pays in advance a premium for the instrument. The amount of payments for each period is determined by the difference between the value of the reference interest rate and the level of protection, taking into account the length of the period, the face value of the agreed principal and the interest rate convention. In combination with an asset, the payments on which depend on a floating interest rate index, the interest rate can provide predictability of cash flows on exposure.

The reference interest rate index can be: Euribor – for transactions in EUR, Libor in USD – for transactions in USD, Libor in CHF – for transactions in CHF.

The frequency of payments depends on the maturity of the reference interest rate. For example, for one-month Euribor or one-month Libor, the frequency is one-month, and for three-month Euribor and three-month Libor, the frequency is three-month.