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Interest & Foreign Exchange Management

What is an interest cap warrant?

For a one-time payment at the start of the term interest cap warrants limit the reference interest rate on which the loan is based. A EUR interest cap warrant guarantees the right to receive quarterly compensation if the underlying EURIBOR has exceeded a certain strike.
The interest cap warrant is a suitable tool if you want to limit your interest rate risk for your loan. Especially if you want to benefit from low interest rates and you can not assess the further interest rate development, the interest cap warrant offers a protection in this regard.

We distinguish:
* bullet interest cap warrants: the protected volume remains the same until maturity of the interest cap warrant.
* obliterative interest cap warrants: the protected volume by the interest cap warrant is linearly reduced to zero at maturity.
* part-obliterative interest cap warrants: the protected volume by the interest cap warrant is linearly reduced to a certain amount at maturity, as shown in the redemption plan.
* forward start interest cap warrants: the protection starts at a later date in the future.

How does the interest cap warrant work?

Assuming you have a loan which is linked to the 3-month EURIBOR. On the one hand, you want to benefit from the low interest rates (i.e. not agree on a fixed interest rate for the loan) and on the other you want to be protected against rising interest rates.

Let's take a look at the loan in detail:
3-month Euribor: 0.25% p. a.
+ customer margin: 1.75% p. a.
Interest rate of the loan: 2.00% p. a.

Imagine buying an interest cap warrant with a strike (= cap) of 2.50% p. a. The 3-month EURIBOR rises to 4.00% over the next few years. Then you receive a quarterly payout starting at a market interest rate of 2.50%. The payout is the positive amount from the current 3-month EURIBOR at the reporting date minus the strike (in our example 2.50%). Please note that the customer margin is not included.


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