on page 454 Volume 5. It is stated at the bottom paragraph:
" A collar establishes a range, the cap exercise rate minus the floor exercise rate, within which there is interest rate risk. The borrower will benefit from falling rates and be hurt by rising rates within that range. Any increases above the cap exercise rate will have no net effect, and any decreases below the floor exercise rate will have no net effect."
I am not sure I understand what they are trying to say here. Even their examples seems to show the contrary to those statements. if rates are falling toward the floor exercise rate, that leads to the cap being out of the money but the floor being still in the money. This increases the effective interest rate. So how is the borrower benefiting from this?
Also if rates rise above the cap exercise rate, then the cap is in the money but the floor is out of the money. This should lower the effective interest rate, not have no effect.
Is anyone seeing it differently? I am thinking I am just not getting what they are trying to say here.
Help appreciated. |