Consider a security that has a coupon rate that floats off of the London Interbank Offered Rate (LIBOR). Such a security might pay a coupon rate of Libor plus 50 basis points. However, if there is a cap that limits the coupon to 7 percent, then when LIBOR reaches percent, any further increases in LIBOR will not result in any increases in the coupon rate on the security. Floating-rate investments with interest rate caps include CMO floaters and adjustable-rate mortgage (ARM) securities. The longer cash flows remain outstanding on such securities, the greater.
