The buyer of an interest rate collar purchases an interest rate cap while selling a floor indexed to the same interest rate. Borrowers with variable-rate loans buy collars to limit effective borrowing rates to a range of interest rates between some MAXIMUM, determined by the cap rate, and a minimum, which is fixed by the floor strike price; hence, the TERM "collar." Although buying a collar limits a borrower's ability to BENEFIT from a SIGNIFICANT decline in market interest rates, it has the advantage of being less EXPENSIVE than buying a cap alone because the borrower earns premium income from the sale of the floor that offsets the cost of the cap. A zero-cost collar results when the premium earned by selling a floor exactly offsets the cap premium.

The buyer of an interest rate collar purchases an interest rate cap while selling a floor indexed to the same interest rate. Borrowers with variable-rate loans buy collars to limit effective borrowing rates to a range of interest rates between some maximum, determined by the cap rate, and a minimum, which is fixed by the floor strike price; hence, the term "collar." Although buying a collar limits a borrower's ability to benefit from a significant decline in market interest rates, it has the advantage of being less expensive than buying a cap alone because the borrower earns premium income from the sale of the floor that offsets the cost of the cap. A zero-cost collar results when the premium earned by selling a floor exactly offsets the cap premium.