Skip to content

ACCA Applied Skills · Financial Management · Hedging techniques for interest rate risk

A company with floating-rate borrowings buys an interest rate cap at 6% and simultaneously sells an interest rate floor at 3%. What is this combination known as?

This is an interest rate collar. Buying the cap limits the borrower's rate to 6%, while selling the floor at 3% earns premium income that offsets the cap's cost, but means the company cannot benefit from rates falling below 3%.

  1. AA swaption
  2. BA forward rate agreement
  3. CAn interest rate collarCorrect
  4. DA currency swap

Explanation

Buying a cap sets a maximum rate while selling a floor sets a minimum rate, giving a range of 3% to 6%. The premium received from selling the floor reduces the cost of the cap. This combination is an interest rate collar.

Did you get it right without looking?

One question tells you little. A timed set on Hedging techniques for interest rate risk shows your real accuracy, how long you take and where you lose marks.

Practise Hedging techniques for interest rate riskFree diagnostic mock

More Hedging techniques for interest rate risk questions