An interest rate floor is a financial derivative contract that provides protection against falling interest rates. It sets a minimum interest rate level, known as the floor rate, below which the holder of the floor contract will receive payments from the counterparty. Interest rate floors are commonly used by borrowers, investors, and financial institutions to hedge against the risk of declining interest rates.

Key points about interest rate floors include:

1. **Structure**: An interest rate floor is a type of option contract where the buyer (holder) pays a premium to the seller (writer) in exchange for the right to receive payments if interest rates fall below a specified level (the floor rate). The floor contract is typically structured to cover a specific period and may be customized based on the terms of the underlying debt or investment.

2. **Protection Against Falling Rates**: Interest rate floors provide protection to the holder against the risk of declining interest rates. If market interest rates fall below the floor rate specified in the contract, the counterparty is obligated to make payments to the holder to compensate for the difference between the floor rate and the prevailing market rate.

3. **Usage**: Interest rate floors are commonly used by borrowers who have variable-rate loans or investments with floating interest rate exposure. By purchasing an interest rate floor, borrowers can limit their downside risk and ensure a minimum level of interest income or cash flow, even if interest rates decline.

4. **Cost and Premiums**: The holder of an interest rate floor pays a premium to the seller for the protection provided by the floor contract. The premium amount is influenced by factors such as the floor rate, the term of the contract, prevailing market interest rates, volatility, and credit risk considerations.

5. **Flexibility**: Interest rate floors offer flexibility in customizing the floor rate, expiration date, and other contract terms to meet the specific risk management needs of the holder. Floor contracts can be tailored to cover different types of interest rate exposures, including short-term or long-term debt instruments.

6. **Counterparty Risk**: Like other derivative contracts, interest rate floors expose parties to counterparty risk—the risk that the counterparty may default on its obligations. Counterparty risk can be mitigated through proper due diligence, collateral agreements, and using reputable counterparties or clearinghouses.

7. **Relationship with Interest Rate Caps**: Interest rate floors are often used in conjunction with interest rate caps to create an interest rate collar—a combination of options that limits interest rate risk within a specified range. The purchase of a floor and the sale of a cap can create a collar arrangement that provides both downside protection and upside potential within the collar range.

Interest rate floors serve as a risk management tool for mitigating exposure to declining interest rates. They offer protection and stability to borrowers and investors in uncertain interest rate environments, helping them manage cash flow, reduce volatility, and achieve financial objectives.