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Collar

• Is the combination of a long Cap position and a short Floor position. It is sometimes called a range forward or a fence. Generally, it is structured so that the net cost of the collar is zero or close to zero. This means that the debit expense for the long cap premium is offset by the credit received for the short floor premium. This term is also used to define the prepayment speed range for a credit instrument.

• An upper and lower limit on the interest rate on a floating-rate note.

• A Collar also refers to a combination of cap (call option on interest rates) and floor (put option on interest rates). An investor who holds a collar is in effect protected from interest rate increases or interest rate declines.

• Buy a call and sell a put. If a firm buys jet fuel and wants protection against jet fuel increases, it can buy a call option with a higher exercise price than the current price and sell a put option (with lower exercise price than the current price) and limit the price fluctuations to be in between the exercise price of the call and the exercise price of the put.

 
 Embedded terms in definition
 Buy
Call option
Call
Cap
Close
Combination
Credit
Exercise price
Exercise
Firm
Floor
Forward
Interest rate
Interest
Investor
Limit
Long
Net
Note
Offset
Option
Position
Premium
Prepayment speed
Prepayment
Put option
Put
Range forward
Range
Sell
Short
Speed
 
 Referenced Terms
 Jump bond: Are issues which are conditioned on an event or series of events. When the event -such as breaking a prepayment Collar -occurs, it triggers a predetermined movement to another payment arrangement. This type of bond occurs in collateralized obligation structures.

 Pac pos: Are Principal Only issues which are predicated on a predetermined PAC prepayment schedule, range, or Collar.

 Super pac: Is Planned Amortization Class security that has broader prepayment protection due to its wider Collar or prepayment band.

 Z pacs: Are bonds in the Z tranche that accrue or accrete interest similar to the plain Z bond. However, the Z PAC repays principal as well. This principal repayment is defined and conditioned by a prepayment schedule or Collar.

 Zero cost collar: The price of call equals the price of put in a Collar. See collars.Is a transaction which has little or zero cash outlay or cost for the initiating person. Often, a security is held and some protection is sought via a hedging transaction. One example, would be the purchase of an out-of-the-money put (debit) and the sale of an out-of-the-money call (credit). Here, the premiums for the debit and credit are nearly the same. Therefore, there would be little or no cost for the person seeking the hedge. However, this position places a cap on the potential reward for holding the underlying asset. Essentially, the protection does not kick-in until the price of the underlying instrument goes below the exercise price for the put. Generally speaking, it should be noted that if the hedge occurred with both options at-the-money, then the person replicated a synthetic short against an actual long position. For the latter, the hedge would be considered as delta neutral whereas using two out-of-the-money options, the hedge at the origination would not be delta neutral. Rather, it would be computed as a partial hedge when placed.

 
 Related Terms
 Equity collar
Zero cost collar

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