To hedge investments against falling interest rates.
A floor hedges an investment with variable interest rates against falling interest rates. The customer profits from this as long as interest rates remain high or even rise. If they fall below the agreed lower limit, the bank pays the customer the difference between the agreed exercise price and the market interest rate. Floors are interest rate options which are normally concluded for several years while the interest rate is fixed several times over the course of the maturity period, usually every six months. At each fixing, the market interest rate is compared with the floor exercise price. If Libor is below the exercise price, the bank pays the floor purchaser the difference six months later. A premium is paid for a floor.
You are hedged against falling interest rates whilst you continue to profit from stable or rising interest rates.
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