What is Cap Meaning?
In finance, the term ‘cap’ refers to a limit or maximum level set on something, such as interest rates or expenses. Caps are commonly used in various financial instruments to provide protection against unfavorable market conditions or unexpected events.
Types of Caps
There are different types of caps used in finance, including:
- Interest Rate Cap: Limits the maximum interest rate that can be charged on a loan or investment.
- Expense Cap: Sets a maximum limit on the expenses that can be charged on a mutual fund or investment account.
Examples of Caps
For example, let’s say you have a mortgage with an interest rate cap of 5%. This means that even if the market interest rates rise above 5%, you will only be charged a maximum of 5% on your mortgage.
Case Studies
One common example of a cap is a ‘collar’ used in options trading. A collar involves buying a protective put option while simultaneously selling a call option to limit potential losses and gains within a specified range.
Statistics on Caps
According to a recent study, caps are widely used in the insurance industry to limit the maximum payout on certain policies. This helps insurance companies manage their risks and liabilities more effectively.
