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pls, explain more this statement ‘the main disadvantage of interest rate collar is that the benefit from any upside movement is capped by the sale of call option.with just the put option,the full upside benefit would be realised” thanks as always
If they are borrowing money, then they will be happy if interest rates go down but will be worried if interest rates go up.
If they simply buy a put option, then they will be limiting the maximum interest. If interest rates go up then they will exercise the option and limit it. If interest rates go down then they will not exercise the option and get the full benefit of the fall in rates (the upside benefit is another word for getting the full benefit of lower rates).
If they create a collar by also selling a call option, then they will be limiting the minimum interest as well. So if interest rates fall, they will then only benefit down to the minimum interest that they have fixed – if interest rates are lower than this then they will not get any further benefit.
Have you watched my free lectures on interest rate options, and also read my separate note about interest rate collars? If not, then I think you would benefit from them.
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