An interest rate cap is a contract that reduces the exposure of a floating rate borrower (or a liability sensitive bank) to increases in interest rates.

Question

Quizplus · Accepted Answer

An interest rate cap is a type of derivative contract that provides the purchaser with protection against rising interest rates by setting a maximum interest rate level (cap) on a floating rate loan or liability. If interest rates rise above the cap, the seller of the cap compensates the buyer for the difference, thus reducing the borrower's exposure to higher rates.

An Interest Rate Cap Is a Contract That Reduces the Exposure