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GLOSSARYTERMS AS A CREDIT DESK USES THEM

Collar (interest rate)

What is a collar, and how is it different from a cap or a swap?

ONE OF 366 TERMS · FREE · NO SIGNUP

BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED

// THE SHORT ANSWER

A collar is a hedge that keeps a rate inside a band: the borrower buys a cap, which sets a ceiling on its base rate, and sells a floor, giving up the benefit of rates falling below a lower level. With a cap at 5% and a floor at 3%, the borrower pays a base rate of 5% if the market reaches 6% and 3% if it drops to 2%, plus its margin either way. Selling the floor pays for some or all of the cap, but the borrower can then owe the bank money, so a collar uses a derivative credit limit where a bought cap does not.

BASIS  Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.

// WHAT IT IS NOT

An interest rate cap is bought outright and only ever pays out; a collar sells a floor to pay for the cap, so, like a swap, it can leave the borrower owing the bank.

// WORKED IN

// NEXT TO IT

RATES AND CURRENCY

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