Interest Rate Floor And Collar

This is a short article to explain what an interest rate collar is and how interest rate options may be used to create one.

Interest rate floor and collar.

The cap rate is set above the floor rate. A depositor would buy a floor and sell a cap. Interest rate floors are utilized in derivative. If we are borrowing money then we can fix a maximum interest rate by buying a put option.

Whenever the interest rate is above 10 the investor will receive a payment from. Hence the investor goes long on the cap floor that will save it money for a strike of x s1 but at the same time shorts a floor cap for a strike of x s2 so that the premium of one at. In an interest rate collar the investor seeks to limit exposure to changing interest rates and at the same time lower its net premium obligations. A borrower would buy a cap and sell a floor thereby offsetting the cost of buying a cap against the premium received by selling a floor.

Let s say an investor enters a collar by purchasing a ceiling with a strike rate of 10 and sells a floor at 8. An interest rate collar or floor ceiling is an agreement where the seller or provider of the collar agrees to limit the borrower s floating interest rate exposure to a specified ceiling rate and floor rate. Caps floors and collars 13 interest rate collars a collar is a long position in a cap and a short position in a floor. A collar involves using interest rate options to confine the interest paid or earned within a pre determined range.

So for example if we buy a put option at a strike price of 92 00 then we will be fixing a maximum interest rate of 8. An interest rate collar is the simultaneous purchase of an interest rate cap and sale of an interest rate floor on the same index for the same maturity and notional principal amount. The issuer of a floating rate note might use this to cap the upside of his debt service and pay for the cap with a floor. For example as a borrower with current market rates at 6 you would pay more for an interest rate collar with a 4 floor and a 7 cap than a collar with a 5 floor and a 8 5 cap.