For a given interest rate environment, the amount of the floor premium is driven by three factors: the loan amount protected, the duration of the protection and the floor rate.
Amount protected: the larger the amount being protected, the larger the potential pay-out on the floor. Consequently, the floor premium tends to change in proportion with the amount of loan it is hedging.
Duration: the longer its duration, the more likely that the floor will pay out and the more expensive the floor.
Floor rate: the higher the floor rate, the greater the probability that the floor will pay out (and the larger each payment will be). Accordingly, floors with higher floor rates are more expensive than floors with lower floor rates.
For a given floor structure (amount protected, duration and floor rate) the cost of the floor premium will fluctuate over time based on changes in market expectations regarding the future path of interest rates and interest rate volatility.
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