July 16, 2024 (NO COMMENTS)

Selling the floor can cover majority of cap’s premium

 

With uncertainty over the timing and extent of central bank rate cuts, corporates are increasingly looking to hedge their interest rate risk with collars. The strategies are proving lucrative, with the arbitrage between caps and floors meaning corporates can put on the cap positions at little cost. A collar involves a corporate buying a cap that pays out if interest rates rise above the option’s strike rate. The corporate simultaneously sells an interest rate floor – if the actual rate goes below