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What does interest rate cap mean?

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interest rate cap
Noun

A contract in which its writer guarantees the buyer a maximum cost of funding for a fixed period in exchange for a premium, with the writer paying the buyer any difference between the negotiated interest (cap rate) and the higher market reference rate on the notional principal amount on any reset date for the interest rate period.

Synonym(s): 
  • cap.
Comment: 
They are virtually always OTC and only rarely traded on an exchange.
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