zero cost collar Q option, correct, position, interest, equivalent

grharmeyer

Any takers to help explain the rationale here for C? Their answer is not clicking...





A LIBOR based floating rate bond combined with a LIBOR based zero cost collar (a long position in an interest rate cap and a short position in an interest rate floor both at a strike rate such that the collar has zero value) is equivalent to a:

A) call option on a bond.

B) pay-fixed swap position.

C) fixed-rate bond.







Your answer: B was incorrect. The correct answer was C) fixed-rate bond.

The effective rate above the cap strike and below the floor strike, when combined with the floating rate on a bond, is constant. (Study Session 17, LOS 62.b)