ACCA Financial Management (F9) Certification Practice Exam

Which term describes an option that sets a lower limit to interest rates?

1. Interest rate cap

2. Interest rate collar

3. Interest rate floor

4. Interest rate futures

The correct answer is: Interest rate floor

An interest rate floor refers specifically to an option that establishes a minimum interest rate that can be charged or paid on a financial instrument, such as a loan or a bond. This term is used to protect borrowers or investors from declining interest rates, as it guarantees that the interest rate will not fall below a certain level. In the context of financial instruments, the interest rate floor is beneficial for parties receiving interest payments, such as holders of floating rate debt, since it provides a safeguard against adverse movements in interest rates. Any rate below this established floor would simply not apply, ensuring a minimum return or payment level. Understanding this concept is crucial when managing financial risk in fluctuating interest rate environments.