An Interest Rate Cap (Cap) is an interest rate risk management tool that provides the borrower with protection against adverse rate movements above an agreed “Strike” or maximum interest rate.
It allows you to cap the interest costs on variable borrowings at the Strike rate, thereby providing you with cashflow protection. A Cap is used for the purpose of protection against adverse interest rate movements, and there is also opportunity to benefit from a fall in interest rates should that occur during the term of the Cap.
A Cap allows you to tailor your risk management policy in relation to interest rate movements without affecting the underlying borrowing, and the cost is paid by way of an upfront premium. The premium cost will be dictated by factors such as the Strike rate, the term and the rollover dates you have requested, but will also be impacted by market volatility.
It is important to be aware that a Cap only affects the base interest rate applicable to your underlying lending facility (it is typically measured against EURIBOR or LIBOR). It has no effect on any acceptance or other fees and margins payable under that facility, and you remain obligated to pay those fees and margins regardless of any Interest Rate Cap arrangements.
If you decide to terminate the Cap prior to the maturity date, you may do so and will not incur any break cost. The Cap may (depending on such factors as time decay and interest rate volatility) have a residual value at the time of the break, which can be paid to you at termination.
This information is intended as an introduction to this product and doesn’t fully explain the benefits and potential risks associated with this and derivative products in general. Your AIB Customer Treasury Services relationship manager will be happy to meet with you and discuss your requirements, and to explain the benefits and potential risks associated with each interest rate hedging product. You should seek your own independent advice on the legal and financial aspects prior to entering into any derivative transaction.
Talk to Us
We offer a range of products to manage Interest Rate risk, including the “Vanilla” ones outlined here to the more structured products which can be tailored to address your specific requirements. Please contact us and we will be happy to discuss all of these with you.