Cap

1. An option hedging structure which effectively establishes a maximum worst case hedged rate or price for a cash outflow or a liability, while allowing the holder of the cap to retain the potential benefit of more favourable lower market rates or prices. If creating a cap for an extended period the transaction can be structured into a series of "caplets", each caplet being for a set period coinciding with the interest periods of the borrowing being hedged eg 3 month LIBOR.

2. A risk management arrangement whereby limits are placed on the positions that participants in an interbank funds transfer system can incur during the business day.

They may be set by each individual participant or by the body governing the transfer system; they can be set in multilateral net, bilateral net or (less commonly) gross terms and can be either a credit cap or a debit cap; for example, bilateral net credit caps, set by an individual participant, will constitute a limit on the credit exposure which that participant will accept in relation to each other participant.

In contrast, sender net debit caps, which may for example be set by the governing body of the clearing system based on a particular formula, limit the aggregate value of transfers that an individual participant may send to all other participants over and above its incoming transfers.

Sender net debit limits may be either collateralised or uncollateralised.

See also

• Capped FRN
• Collar hedge
• Floor
• Interest rate cap
• Interest rate collar
• Notional amount
• CertICM