Interest Rate Collar
An interest rate collar is a combination of an interest rate cap and an interest rate floor. It serves to limit the range of interest rate fluctuations on a variable-rate loan. A borrower who uses a collar agrees to an upper limit on the rate (cap) and in return gets a lower limit (floor). If the interest rate falls below the floor, the borrower compensates the seller, and if it rises above the cap, the seller compensates the borrower. This strategy is useful for real estate investors who want to budget for a range of interest payments, minimizing the risk of rate volatility.
Modeling an interest rate collar involves modeling the floating rate debt, but with a MIN() function to ensure the all-in rate does not exceed the cap together with a MAX() function to ensure the all-in rate does not fall below the floor during the term of the cap.
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