Interest Rate Collar
An interest rate collar can be an effective way of hedging interest rate risk associated with holding bonds. Since a bond's price falls when interest rates go up, the interest rate cap can guarantee a maximum decline in the bond's value. While interest rate floor does limit the potential appreciation of a bond given a decrease in rates, it provides upfront cash to help pay for the cost of the ceiling.
Let's say an investor enters a collar by purchasing a ceiling with a rate of 10% and sells a floor at 8%. Whenever the interest rate is above 10%, the investor will receive a payment from whoever sold the ceiling. If the interest rate drops to 7%, which is under the floor, the investor must now make a payment to the party that bought the floor.
Investment dictionary. Academic. 2012.
Look at other dictionaries:
interest rate collar — Under a collar arrangement, both an interest rate cap and an interest rate floor are sold simultaneously. The buyer ensures that if interest rates move outside an agreed range, it will receive payment from the seller. Related links collar… … Law dictionary
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Collar (finance) — In finance, a collar is an option strategy that limits the range of possible positive or negative returns on an underlying to a specific range. Contents 1 Equity Collar 1.1 Structure 1.2 Example 2 … Wikipedia
Collar — An upper and lower limit on the interest rate on a floating rate note. The New York Times Financial Glossary * * * A derivative instrument which fixes interest payments within a certain range by combining a long cap and a short floor. The… … Financial and business terms
collar — / kɒlə/ noun 1. purchasing fixed minimum and maximum rates (‘floors’ and ‘caps’) of interest, dividends or repayments at the same time 2. ⇒ white collar COMMENT: If a company has money in variable rate investments and wants to protect its income … Dictionary of banking and finance
collar — An arrangement in which both the maximum ( cap) and minimum ( floor) rate of interest payable on a loan are fixed in advance … Accounting dictionary
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cap and collar — ˌcap and ˈcollar noun [singular] 1. BANKING an agreement by a lender not to go above or below certain interest rates on a particular loan: • The mortgage lenders have introduced a cap and collar deal with an upper rate of 7.75% and a floor of… … Financial and business terms