Knowledge

Interest Rate Floor

A contract that guarantees a minimum level of LIBOR. A floor can be a guarantee for one particular date, known as a floorlet. A series of floorlets, or floor can extend for up to 10 years in most markets. In return for making this guarantee, the buyer pays a premium. Floors generally guarantee a minimum level of either 3 or 6 month LIBOR or whatever the prevailing floating rate index is in the particular market. The clients maximum loss on a floor transaction is the premium. After purchasing the Floor, the buyer can make "claims" under the guarantee should LIBOR be below the level agreed on the floor on the settlement dates. A floor is not a continuous guarantee, it is only date specific. This means claims can only be made on specified dates. These dates are selected by the purchaser. Should the buyer never be required to make a claim under the floor, the option will expire worthless.