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Thursday, January 12, 2012

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A Collar is a hedging instrument consisting of two combined options. By using a Collar, the interest cost of an underlying transaction is being limited within a preset range. Hence, a Collar combines the results of both Cap and Floor.

This can be used for example for a floating rate financing: The cap limits the maximum interest cost while the floor sets a minimum interest level. By accepting a minimum interest level, the holder of the Collar receives a premium income that subsidizes the cost of the Cap and thus optimizes the cost of the total hedge transaction.

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