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Dear John,
After spending yesterday evening revising interest rate hedging, I think it is finally sinking in!!! 🙂 However, I am a little confused over interest rate collars.
I thought options were only ever bought (then we have the right to exercise them or leave them unexercised), but according to the answer to Q2 Dec ’11, for a collar we buy put options to borrow and reduce the cost by offsetting the selling of call options. To clarify a couple of things in particular
1. If we are depositing do we buy call options and sell put options?
2. If we are selling the call options, would we not have to buy them back at some stage to cancel them out?I look forward to your comments
Best Regards
In answer to your first question – yes 🙂
With regard to the second question, for the exam it is best viewed as though you are on option dealer. So if the buyer decides to exercise the option then we (as the seller) will have to pay to them their profit, whereas if the buyer decides not to excercise then we have to pay out nothing.
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