An agreement under which the bank (the seller of the agreement) pays you (the buyer of the agreement) compensation if the variable interest rate (e.g. Euribor 3m, Euribor 6m) falls below the level of the agreed price during the agreed period of time.
You pay a one-off premium to the bank, which is usually paid on the transaction date.
Agree on the acceptable terms
- The option to set the lowest variable interest rate for the entire period
- The minimum transaction amount is 1 million euros
Risks
The premium is non-refundable once the agreement has been signed.
For example, if market interest rates exceed the agreed price level during the agreed period, the buyer would bear a cost equal to the premium paid if the interest rate were below the floor.
Floor transactions are carried out over the counter between the bank and the customer.
Example
Let us assume you signed an interest rate floor agreement on 1 January 2021.
Basic terms
Transaction amount: 1 million euros
Maturity date: 5 years
The floor set by you: 0.50%
Variable interest rate: EURIBOR 6M
You pay the bank a transaction fee (premium) in the amount of: 16,000 euros
- On 1 July 2021, EURIBOR 6M is 0.60%.
No amount is due to you from the bank as the variable interest rate has not reached the set 0.50% limit.
- On 1 January 2022, EURIBOR 6M falls to 0.30%.
The bank pays compensation to you for increased interest expenses:
1,000,000 × (0.50 – 0.30)% × 180 / 360 = 1,000 euros
The same principle applies to the calculation of other payments until the completion of the transaction, i.e. 1 January 2026.
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Markets in Financial Instruments Directive
The Markets in Financial Instruments Directive (MIFID) regulates the rendering of financial investment services has been effective in the European Union and the European Economic Community (EEC) since 2007. The requirements of MiFID are aimed to provide additional protection to investors and promote the transparency of financial markets in terms of transactions in financial instruments.
After 3rd January 2018, new rules of the Markets in Financial Instruments Directive 2014/65/EU (MiFID II) came into force and affect each investor who engages in transactions in financial instruments.
After 3rd January 2018, new rules of the Markets in Financial Instruments Directive 2014/65/EU (MiFID II) came into force and affect each investor who engages in transactions in financial instruments.
Please note that the data, examples and information on derivative financial instruments provided herein is for informational purposes only. This information has been prepared without consideration or regard of your knowledge or experience related to specific financial instruments and without having any information about your investment objectives or financial capacity to assume risks related to the conclusion of the transaction that meets your investment objectives; therefore, it cannot be construed as a personal investment recommendation, advice on trading in derivative financial instruments or investment research, order or invitation to buy or sell specific financial instruments and may not constitute any basis or part of any subsequent transaction.
