Interest Rate Cap Floor And Collar

The call and put options take on the role of caps and floors.

Interest rate cap floor and collar.

An interest rate collar is an option used to hedge exposure to interest rate moves. A collar involves selling a covered call and simultaneously buying a protective put with the same expiration establishing a floor and a cap on interest rates. This organization has purchased a 5 cap and sold a 2 floor which provides the organization with an interest rate collar of 2 to 5. Associated bank offers interest rate swaps structured with collars.

The premium for an interest rate collar also depends on the rollover frequency and how you make your premium payments. Indeed its interest rate delta is negative. Time 0 5 6 004 0 470 4 721 0 021 35 0 06004 0 04721 0 470 0 021 ir modeling a capped floater. It is a type of positive carry collar that is constructed by simultaneously purchasing and selling of out of the money calls and puts with the strike prices of which creating a band encircled by an upper and lower bound.

It protects a borrower against rising rates and establishes a floor on declining rates through the purchase of an interest rate cap and the simultaneous sale of an interest rate floor. Caps floors and collars 8 interest rate sensitivity of a cap the cap pays off when interest rates go up. Typically the premium of the cap is designed to exactly match that of the. As seen from the table borrower is already reducing its premium costs to 100 000 80 000 20 000 buy selling floor and also limiting its interest costs at 5 when interest rate rises above the cap level.

As stated before a collar establishes a defined range floor and cap of interest rates the hedger is subjected to as opposed to a single fixed swap rate. If the benchmark rate exceeds the cap associated bank pays you the difference for the period. 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. Table 3 interest rate collar example.

We compare each period s interest rate to a benchmark rate typically libor. Caps floors and collars 13 interest rate collars a collar is a long position in a cap and a short position in a floor. Therefore it is a bearish position in the bond market. Imagine buying a 1 70 libor cap and selling a 1 70 floor.

An option based strategy that is designed to establish a costless position and secure a return. 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.