Interst rate hedging

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    dazhong0703
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    What are the differences between interest rate guarantee, interst rate cap/floor/collar, and interst rate options, pls? Why are the benefits to choose one of them, but not others, pls?
    Thank you.


    Avatar of John Moffat
    John Moffat
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    An interest rate guarantee fixed the interest rate. That is great in terms of the fact that there is no risk of it changing, but not so good it you expect interest rates to fall (assuming you are borrowing).
    Interest rate options let you get the benefit of lower interest rates, but limit the maximum. The downside is that there is a premium payable whether or not you exercise the option. (Limiting the maximum interest rate is fixing a cap; if we were investing then we would want to limit the minimum interest rate – this is a floor).

    Using a collar means we can fix a maximum interest rate but reduce the net premium by accepting also a minimum interest rate (again, assuming we are borrowing money).

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