AFMP4
Syllabus E. Treasury And Advanced Risk Management Techniques E3. The use of financial derivatives to hedge against interest rate risk

E3a. Interest rate collar 10 / 13

Syllabus E3a)

iv) Interest rate options (including collars)

Interest rate collar

A collar involves the simultaneous purchase and sale of both call and put options at different exercise prices

The main advantage of using a collar instead of options to hedge interest rate risk is lower cost.

However, the main disadvantage is that, whereas with a hedge using options the buyer can get full benefit of any upside movement in the price of the underlying asset, with a collar hedge the benefit of the upside movement is limited or capped as well.