Cap Floor Collar

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

Cap floor collar.

While the collar effectively hedges. An option based strategy that is designed to establish a costless position and secure a return. When considering a swap it s important to remember the hedger s potential opportunity cost. Interest rate swap in hedging variable rate debt with a swap an organization agrees to pay out a fixed amount each month to a counterparty in exchange for receipt of a variable rate.

An interest rate collar can be created by buying a cap and selling a floor. If rates stay below the hedged swap rate 1 70 in the graph below. Or investor may buy a floor to avoid any future falls in the interest rates. Buying a put option at strike price x called the floor selling a call option at strike price x a called the cap.

A collar is simply a swap with a range the floor and cap customized by the hedger to meet their unique goals and objectives. 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. Caps floors and collars 9 floor and floater coupons floor rate coupons of floater with a floor example. Buying the underlying asset.

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. A collar is created by. Pure inverse floater 6 2 times fixed 3 minus floating. Caps floors and collars 10 consider 100 par of a 2 year inverse floater paying 6 minus the 6 month rate.

Caps floors and collars are option based interest rate risk management products that put limits to the interest rates. Underlying risk reversal collar. 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. The premium for an interest rate collar also depends on the rollover frequency and how you make your premium payments.

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 creates an interest rate range and the collar holder is protected from rates above the cap strike rate but has forgone the benefits of interest rates falling below the floor rate sold. The premium income from selling the call reduces the cost of purchasing the put. A barrower may want to limit the interest rate to avoid any rises in the future and buys a cap.

Cap and floor payoffs and interest rate collars. If the coupon cannot go below zero the value of the inverse floater is the value of the pure inverse floater with no floor plus a cap with strike rate 6.