Kapie

Nielsen - are you in Washington DC?

I think you are correct - a collar, where you buy the cap and sell the floor, is used to hedge a floating liability from rising rates (if it exceeds the cap strike, you can exercise. Although your floating liability has gone up, you get payment from exercising the cap which offsets the higher liability). A reverse collar, where you sell the cap and buy the floor protects a floating asset (if rates move down, you exercise the floor, receiving payments that offset the decrease of floating rate payments). Each of these is fully or partially funded by selling the other side short (sell a floor and use proceeds to buy a cap and vise versa)


The way i keep these straight is thinking about it from trading options. A collar is used to protect a stock that has gains (sell calls ont eh stock, use proceeds to buy a protective put). This is the same idea as a reverse collar on the interest rates (sell the cap and buy the floor).