Interest rate option Guide, Meaning , Facts, Information and Description
An interest rate option is a derivative security where the underlying asset is the right to pay or receive a (usually notional) amount of money at a given interest rate.Interest rate derivatives are the largest derivatives market in the world. In January 2004 The Economist quoted figures from the Bank of International Settlements that say 5.5 trillion dollars of derivatives by notional value (out of total derivatives market of 8 trillion dollars).
According to the International Swaps and Derivatives Association, 80% of the world's top 500 companies at April 2003 used interest rate derivatives to control their cashflow. This compares with 75% for foreign exchange options, 25% for commodity options and 10% for equity options.
Examples
An interest rate option which ensures the purchaser pays a maximum interest rate is known as an interest rate cap.
An interest rate option which ensures the purchaser receives a minimum interest rate is known as an interest rate floor.