Interest rate floor
A floor can protect a depositor or lender against falling floating-rate income. The holder receives the specified difference when the benchmark is below the floor and can benefit from higher rates, after considering the premium. A borrower may instead sell a floor as part of a collar, accepting a lower boundary on the benefit of falling rates in exchange for premium income. The reference rate, notional and reset dates determine the coverage. A floor is not a promise that every component of investment income is guaranteed.
Worked example
A depositor buys a 3% floor on its reference rate. If that reference falls to 1%, the contract pays the covered 2 percentage point difference under its terms. If the depositor separately pays fees, its net return can still be below 3%.
Common mistake
Assuming selling a floor provides the borrower with extra protection against falling rates; it gives the buyer the protection and creates an obligation for the seller.
Where it appears in your exams
| Qualification | Exam | Relationship | Period |
|---|---|---|---|
| ACCA | AFM | Direct | September 2026–June 2027 |
| ACCA | FM | Direct | September 2026–June 2027 |