what is a cap (and floor) — a few points

Jargon warning — a bond has an _issuer_ and a _lender_ who receives coupons
Jargon warning — an option in Eq/FI has a _holder_ and a _writer_
Jargon warning — Don't worry about the concepts of “caplet” or “cap”. First understand the basics of call option.

A cap is an instrument combining a floating bond + an option, Specifically, a cap models “paying-capped-floating-coupon” using “holding a call option”. This sounds a mouthful, but in plain English, “I pay you a floating coupon but you write me a call option”

A call option's payoff has infinite upside. A floating coupon is also unlimited. A floating bond issuer has unlimited cost, so he needs an equally unlimited protection.

As a bond issuer, I issue a floating bond but hold a call option (as protection).

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