Availability of Functionality
There are two ways in which PrecisionLender handles Caps and Floors:
- If your bank has the Caps and Floors option enabled, then you will see additional options while pricing Floating and Adjustable loans.
- If your bank does not have the Caps and Floors option enabled, then caps and floors are handled in a very simple way: they only affect the ROE if they are In-The-Money. In this case, a warning is given.
Setting Caps and Floors on a loan
For Floating (or Adjustable) loans, you can define a schedule of caps and floors. Most common would be a simple cap or a simple floor:
However, you are also able to add scheduled steps to the caps and floors. One common case for this would be to offer a low cap during the first 12 months of a loan which increases at the 12-month mark. This type of loan may alleviate a customer's concerns about near-term interest rate risk while not significantly impacting the ROE of the loan:
Calculating the Zero-Cost Collar for a loan
In some situations where the customer wants or needs a rate cap, PrecisionLender can be used to easily calculate a corresponding Floor that will result in the same overall ROE for the loan. This is called the Zero-Cost Collar and can be calculated by:
- Set up your floating loan with no cap or floor and use Andi to obtain your target ROE (by adjusting the rate, fees, structure, etc.)
- Open the Caps and Floors option and enter the desired cap rate... You may see your ROE drop and the amount will be determined by the cap.
- Now place your cursor into the Floor field and use your up and down arrows (or mouse scroll wheel) to crank up the floor until it brings the ROE back to its original value. This combination of Cap and Floor represents the Zero-Cost Collar for this loan.
For Adjustable loans, you will see an additional tab named "Adjustment Maximums" where you can enter the maximum adjustments at various stages of the life of the loan.
"Moneyness" of Caps and Floors
- At-the-Money: The Cap or the floor is equal to the current rate
- In-the-Money: The cap or floor is affecting the rate. An In-the-Money Cap is below the current rate and an In-the-Money Floor is above the current rate.
- Out-of-the-Money: The cap or floor is not altering the rate. An Out-of-the-Money Cap is above the current rate and an Out-of-the-Money Floor is below the current rate.