What Is an Annual Cap?

The interest rate ceiling is the maximum limit that a fundraiser can use to purchase an option contract to lock its fundraising rate. A selective form of interest rate swap. When the fundraiser gets a floating interest rate debt, it pays a certain option fee to purchase an interest rate option contract. The contract price plus the corresponding option fee expenditure is the upper limit of the interest rate. When the interest rate fluctuates below the agreed price, no interest rate swap is performed and the funder pays the interest on its own; when the interest rate rises to the agreed price, the funder exercises the option and the initial seller of the option contract pays the floating interest rate for it Interest payments, while fundraisers only pay interest at a fixed rate based on the agreed price, realizing interest rate swaps. ^[1]

Interest rate cap

Right!

The interest rate ceiling is the maximum limit that a fundraiser can use to purchase an option contract to lock its fundraising rate. A selective form of interest rate swap. When the fundraiser gets a floating interest rate debt, it pays a certain option fee to purchase an interest rate option contract. The contract price plus the corresponding option fee expenditure is the upper limit of the interest rate. When the interest rate fluctuates below the agreed price, no interest rate swap is performed and the funder pays the interest on its own; when the interest rate rises to the agreed price, the funder exercises the option and the initial seller of the option contract pays the floating interest rate for it Interest payments, while fundraisers only pay interest at a fixed rate based on the agreed price, realizing interest rate swaps. ^[1]

Chinese name

Interest rate cap

Foreign name

interest rate cap

Subject

economics

Scope of application

financial

Interest rate cap

The ceiling is a percentage that the state allows commercial banks to raise based on the benchmark interest rate. Because the state has set a benchmark interest rate, each commercial bank can fluctuate above and below the benchmark interest rate given by the central bank according to its own situation. The upper and lower limits are the scope of this interest rate fluctuation. For example, the benchmark interest rate is 5.58%, and the upper limit is a 10% increase, which is 6.138%, which is 5.58% × (1 + 10%).

The Supreme Court issued the Regulations on Several Issues concerning the Application of Laws in the Trial of Civil Lending Cases, which clarified that the annual interest rate ceiling for private loans was adjusted to 24%, and the annual interest rate exceeding 36% was invalid. Previously, the ceiling on the annual interest rate of private lending was based on four times the interest rate of similar banks in the same period.

Financial product

The interest rate cap means that the customer has reached an agreement with the bank to specify a certain market reference interest rate and at the same time determine an interest rate cap level. On this basis, the seller of the interest rate ceiling promises to the buyer: within the specified period, if the market reference interest rate is higher than the agreed interest rate ceiling level, the seller pays the buyer the difference in the market interest rate above the interest rate ceiling; if If the market reference interest rate is lower than or equal to the agreed rate ceiling, the seller has no obligation to pay.

Application of interest rate caps

In an interest rate cap transaction, the parties to the transaction usually need to clarify the following main content.

Transaction currency and amount: Usually the principal of the borrower's loan.

Validity period: The period during which the borrower needs to guard against interest rate risk.

Strike Price: The highest level of interest rate that the borrower can bear.

Interest payment period: The borrower's interest payment period, that is, the time interval of each set day period, usually adopts the term of the London Interbank Lending Rate, such as once every three months and once every six months.

Reference interest rate: As the market interest rate level, the London Interbank Lending Rate for each period is usually used.

The interest rate cap option fee is usually paid in a one-off manner, and its quoted price is different from the interest option option price quoted method. For example, if the borrower buys an interest rate ceiling, the amount is 10 million US dollars, the validity period is 3 years, the exercise price is 6%, the reference interest rate is the three-month London Interbank Lending Rate, and the option fee is quoted at 1.5%. The actual amount of option premium to be paid is:

10000000 × 1.5% = 150000 (USD)

Within the validity period of the interest rate cap, several interest payment days can be determined. At each capital delivery, the delivery amount paid by the seller to the buyer is calculated as follows:

S = A * (LK) * T / B

Among them, S: the delivery amount of each period;

A: interest rate cap transaction amount;

L: reference interest rate level;

K: strike price;

T: number of days per interest payment period;

B: The number of days in a year, 360 or 365, depending on different currencies and different market practices.

When L is greater than K, the seller pays the S amount to the buyer. When L is less than or equal to K, the two parties of the transaction do not receive and receive funds. The settlement amount for each period of the interest rate cap usually occurs at the end of the period. However, in some cases, the two parties to the transaction may agree to pay at the beginning of the period. At this time, the delivery amount must be calculated at the beginning of the discounted amount based on the reference interest rate. ^[2]