Interest rate option - Definition and Overview

An interest rate derivate 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. Market observers estimate that $60 trillion dollars by notional value of interest rate derivatives contract had been exchanged by May 2004.

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.

See also

• Interest rate swap
• Swaption

Example Usage of Interest