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Interest Rate Collar

An interest rate collar is the simultaneous purchase (sale) of a cap and sale (purchase) of a floor. The firm constructing the collar earns a premium from the sale of one side to cover in part or in full the premium expense of purchasing the other side of the collar. If the two premiums are equal, the position is often referred to as a zero-premium collar.

Interest rate collars allow the firm to retain some of the benefit of declining rates while removing the unpleasantness of paying an up-front option premium for the cap. This unpleasantness can be mitigated, or totally eliminated in the case of a zero-cost collar, by the firm simultaneously selling a floor option of a suitable strike rate.

Interest rate collar is a combination of an interest rate cap and an interest rate floor; puts brackets around the movement of a loan rate so that it cannot rise above the cap or fall below the floor.

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