ACCA FM · Chapter 14 · Question 9 of 10
A company with variable rate borrowing buys an interest rate cap and simultaneously sells an interest rate floor at a lower rate. What is this arrangement called and what is its main advantage?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: B) An interest rate collar, which reduces the net premium cost of protection against rising rates
Explanation
A collar combines buying a cap (protecting against rates rising above a ceiling) with selling a floor (giving up the benefit of rates falling below a lower limit). The premium received for the floor offsets some or all of the premium paid for the cap, so protection is cheaper, but the company does not benefit from rates falling below the floor.
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