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Caps, Floors, and Collars

An interest rate cap is designed to provide insurance against the interest expense from a floating rate loan exceeding a certain range. That is, a cap will have a positive payoff when the reference interest rate ends up above the fixed rate specified in the contract. The borrowing entity still pays an amount of interest based on periodic fixing of the floating rate, but when that exceeds the interest 'cap' the net cost of borrowing is partially offset by the payoff from the option.

An interest rate floor on the other hand is analogous to a standard put option. The holder of the floor will receive a payoff when the reference interest rate falls below the benchmark rate, and this structure can therefore be used to guarantee a minimum return for a lender.

A collar is simply the combination of a long position in a cap and a short position in a floor, and is typically used to ensure that the cost of floating-rate debt does not fall outside of a certain range.

The caps, floors, and collars functions are split into 2 groups, with the functions in the second group capable of dealing more complex IRO instruments. The prefixes for the function groups are as follows:

Function Group Prefix

Description

 

.

 

oIRcap1

Functions that can be used to handle most vanilla style interest rate options.

 

oIRcap2

Functions that can deal with a range of custom features such as stub periods, an amortization schedule for the face value, variability in strike rate and support for a volatility curve .

 

 

Within each group of functions there are common function types:

Function Name

Description

 

.

 

_Dates

Displays the reset and payment dates for an interest rate cap, floor or collar.

 

_Price

Calculates the fair value and risk statistics for an interest rate cap, floor or collar.

 

_CFM

Displays the cash flow map information for an interest rate cap, floor, or collar.

 

_ZCC

Calculates the required strike rate for a zero-cost collar.

 

 

 

 

In This Section

Background to Caps, Collars, and Floors

Cap, Floor and Collar Functions

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