Which of the following best describes a zero cost collar within the context of interest rate derivatives?
A)A zero cost collar is a long (short)position in an interest rate cap and a short (long)position in an interest rate floor where the cost of the cap (floor)exactly offsets the revenue from the floor (cap).
B)A zero cost collar is a long (short)position in an interest rate cap and a short (long)position in an interest rate floor where the cost of the cap (floor)is less than the revenue from the floor (cap).
C)A zero cost collar is a long (short)position in an interest rate cap and a short (long)position in an interest rate floor where the cost of the cap (floor)is greater than the revenue from the floor (cap).
D)A zero cost collar is an option that pays off only if interest rates remain within a designated range.
E)A zero cost collar is an option that pays off only if interest rates fall outside of a designated range.

Question

Quizplus · Accepted Answer

A zero cost collar is a strategy used to protect against interest rate risk where the cost of the interest rate cap exactly offsets the revenue from the interest rate floor. It involves taking a long position in an interest rate cap and a short position in an interest rate floor. The cap limits the maximum interest rate that can be paid, while the floor ensures a minimum interest rate is received. By combining the two positions, the cost of the cap is offset by the revenue from the floor resulting in a zero cost.

Which of the Following Best Describes a Zero Cost Collar