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Hello sir
In collars company limits its ability to enjoy favourable interest rate movements ,
e.g. company buys put option and it also buys call options at lowest possible premiums ,my question is that this premium is payable no matter it is cap or floor ,
so why we add premium cost (netof cap and floor) in effective interest rateshouldn`t we add both of these cost to the effective interest rate ???
If a company is borrowing money, they will buy a put option (and therefore pay a premium) in order to fix a maximum interest rate.
If they create a collar, then they do not buy a call option – they sell a call option and this limits the minimum interest rate. The only reason for doing this (and limited the minimum interest) is that by selling the call option they receive a premium and this therefore reduces the net premium cost for them.
Our lectures on this together with the separate note on collars (both in this website) should help you.
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