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Interest Rate Floor

What does Interest Rate Floor mean?

The minimum interest rate that would be charged on a contract or agreement with a flexible interest rate when the reference rate falls below the strike rate. An interest rate floor reduces the earning risk to the lender.

Futures Knowledge Explains Interest Rate Floor

For example, an adjustable-rate mortgage may have an interest rate floor stating that the rate will not go below say, 0.5%, even if the reference rate (e.g. 3m LIBOR) the formula used to calculate the interest rate would have it do so. An interest rate agreement in which payments are made when the reference rate falls below the strike rate guarantees a lower bound for the rate of interest received on an investment, when used in conjunction with a long position in a Floating Rate Note (FRN). The rate floor itself provides a periodic payment based upon the positive amount by which the strike rate exceeds the reference rates. Premium is paid to the seller in return for the interest rate guarantee.

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