Indexed Strike Cap
A special purpose cap giving customized interest rate protection at reduced cost, usually with knock-in or knock-out features. Indexed strike caps are used to reduce interim costs under circumstances when cost is an important issue, but they will allow higher interest costs under other circumstances. The diagram illustrates an application called an N-cap because of the shape of its payoff pattern. In the example, the cap buyer holds a 5.0% knock-out cap and a 6.5% knock-in cap. Both caps have an 8.0% trigger rate. The cost of funds is capped at 5.0% plus the cost of the indexed strike cap structure unless rates rise to 8.0%. At 8.0% the knock-out and knock-in features are activated and the net cost of funds jumps. The logic behind the position is that a borrower will be able to pay higher rates in an 8.0% rate environment because business will be stronger and competitors will also be paying high rates. Many other cost patterns are possible. Also called N Cap.
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