An Interest Rate Cap is a series of options contracts on LIBOR that hedge floating rate payers against a rise in interest rates. Borrowers can use these contracts as a way to limit their risk to rising interest rates.
Cap Pricing is driven primarily by two factors: 1) Interest Rate Expectations, and 2) Implied Volatility. Interest Rate Expectations are easy to track. If front-end swap rates (see our home page) move higher, the more likely a cap is to pay out, which increases the cost of the cap. Volatility is the measure of confidence, or lack thereof, that traders have in current rate expectations. The higher volatility is, the greater the range of expected outcomes, the more a trader will charge.
You can browse our Resource Library for more information on how caps work. If you’re new to caps, we recommend starting with:
Interest Rate Caps 101
Time Value Impact on Cap Pricing
Our Cap Team can answer any questions you may have, as well as help provide guidance when structuring a cap. You can contact us at CapTeam@pensford.com, or call us at (704) 887-9880.