A floater (FRN) in which coupon rates (coupon reset rates) are subject to an upper limit. Like standard floaters, capped floaters pay a normal floating rate note coupon up to a specified maximum rate. If rates exceed that limit, the coupon is fixed at the capped rate. For example, a capped floater may have a maximum rate of 7% placed on its coupon reset rates which are currently in the range of 5-6%. Once the market rate rises above 7%, the rate is automatically fixed at 7%. Later on, if the market rate drops below 7% to 6.5%, for example, the coupon reset rate readjusts to 6.5%.
In terms of composition, a capped floater is a combination of a floater with an interest rate cap. However, mathematically, the value of a capped floater is equal to the value of an uncapped floater minus the value of a cap:
Capped floater = uncapped floater – cap
The capped floater is also known as a capped floating-rate note.
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