An Interest Rate Collar is an agreement limiting the range of interest rate fluctuations. It is addressed to businesses that have taken out loans and wish to limit a potential interest rate fluctuation between predefined caps and floors.
Features and benefits
- It enables businesses to lock in an acceptable interest rate range (cap and floor) for their loan repayment.
- The business continues to pay the loan on a fluctuating basis for as long as the Euribor interest rate is within the predefined range.
- The business knows the maximum and minimum possible loan repayment cost at any time.
- The risk from a potential increase in interest rates is significantly reduced, but not completely eliminated for interest rate values within the predefined range.
- Flexible transaction terms (term, amount, repayment plan, interest-bearing period).
- Zero-cost strategy (usually).
- Option to reverse or terminate the transaction earlier.
- Option to set different caps and floors, even per period, with a premium readjustment.
Example
A business has taken out 5-year loans with semi-annual payments and a reference rate of 6-month Euribor. The business has the option to choose zero-cost protection (premium) against a future increase in interest rates by setting the cap and accepting the floor.
The business chooses a 2% cap and a 0.50% floor for the 6-month Euribor. For the 6-month periods when the 6-month Euribor is higher than 2%, the business indirectly pays 2% + spread on their loan obligations. For the 6-month periods when the 6-month Euribor is lower than 0.50%, the business indirectly pays 0.50% + spread on their loan obligations.
The information we provide about Eurobank products and services is general and non-binding.