Caps and Floors floors are known as protected interest rate contracts. A protected interest rate contract can be defined as a contract that for a fee grants the right to benefit fully from a rate move in one direction, while being exposed to only limited risk if the rate goes the opposite way.
The asymmetric nature of the contract leads to two types of contracts:
...
For example, if the Strike Rate on a Floor contract is 5%, and on the reset date the underlying security coupon rate is 4.5%, then the Floor contract would accrue accrues at .5% (Strike Rate - underlying coupon rate). If the coupon rate on the underlying security is 5.5% on the reset date for the same Floor contract, then the security would accrue accrues at 0% since because the underlying security coupon rate is greater than the Strike Rate.
Contrarily, if the Strike Rate on a Cap contract is 5%, and on the reset date the underlying security coupon rate is 4.5%, then the Cap contract would accrue accrues at 0% since because the underlying security coupon rate is greater than the Strike Rate. If the coupon rate on the underlying security is 5.5% on the reset date for the same Cap contract, then the security would accrue accrues at .5% since because the underlying security coupon rate is greater than the Strike Rate.