Interest Rate Floor

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Definition of 'Interest Rate Floor'

An interest rate floor is a type of interest rate cap that sets a minimum interest rate that a borrower will pay on a loan. This means that the borrower's interest rate will never fall below the floor, even if market interest rates decline.

Interest rate floors are often used to protect borrowers from rising interest rates. For example, a borrower who takes out a mortgage with an interest rate floor of 5% will never pay more than 5% interest on their loan, even if market interest rates rise above 5%.

Interest rate floors can also be used to hedge against interest rate risk. For example, a company that expects its interest expenses to increase in the future may purchase an interest rate floor to lock in a fixed interest rate.

Interest rate floors are typically priced based on the level of interest rate risk that the borrower is willing to take on. The higher the interest rate floor, the more expensive the floor will be.

Interest rate floors can be used in a variety of financial transactions, including loans, mortgages, and bonds. They can be a valuable tool for borrowers who want to protect themselves from rising interest rates or for companies that want to hedge against interest rate risk.

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