A cap/floor collar is a predefined strategy constructed by buying and selling a cap and a floor.
You can:
Buy a collar, meaning that you buy a cap and sell a floor both with the same expiry and (typically) notionals but different strike prices.
Sell a collar, meaning that you sell a cap and buy a floor both with the same expiry (and typically) notionals but different strike prices.
Advantages of a Cap/Floor Collar Strategy
A collar protects you from the risk of rising or falling interest rates as relevant while helping to reduce the cost of this protection relative to the purchase of a single instrument.
If you:
Buy a collar you are hedging yourself against rising interest rates. In other words, the buyer receives payments if the reference index fixes above the cap, but makes payments if the index fixes below the floor. The premium received from the sale of the floor reduces or offsets the cost of buying the cap.
However, you will only benefit from a drop in interest rates to the strike of the floor. If the interest rate drops any lower than that, you will have to make a payout to the seller of the collar.
Sell a collar you are hedging yourself against falling interest rates. In other words, the seller receives payments if the reference index fixes below the floor, but makes payments if the index fixes above the cap. The premium received from the sale of the cap reduces or offsets the cost of buying the floor.
However, you will only benefit from a rise in interest rates to the strike of the cap. If the interest rate rises any higher than that, you will have to make a payout to the buyer of the collar.
Pricing a Cap/Floor Collar in SDX Interest Rates
The premium, which is expressed as a percentage of the notional, is usually paid upfront. However, it can also be paid in installments over the life of the cap/floor collar.
The upfront payment to be made for a cap/floor collar is shown in the Market Price result. The Amortize premium result shows the annual periodic payment that would be paid if the cap/floor collar was bought in installments.
By default the Amortize premium result is not displayed. You can choose to display it in the Settings window. For more information see Displaying the Cap/Floor Premium as an Amortized Value .