Sponge_Bob_CFA Wrote: ------------------------------------------------------- > > It doesn’t matter what the floating rate is > because you’ve contracted yourself into a window > which will always contain your effective loan rate > (in this case the window only contains the one > value becuase the strike rate is the same for > floor/cap). Except this part is just not true. A zero cost collar might be long a 9% cap and short a 1% floor or something. That means your LIBOR bond is, uh, essentially a LIBOR bond unless interest rates move a ton. Floating within a range doesn’t mean a fixed rate bond. I think whoever wrote this question needs to think about the zero-cost collar some more.
He also said “zero value”, which could confuse the issue. Zero value when? If you had a 4%/6% collar, and LIBOR moves to 7%, you certainly have value in the collar. His explanation is actually more confusing than if he’d just stuck to saying “zero cost collar”.
JoeyDVivre Wrote: ------------------------------------------------------- > Sponge_Bob_CFA Wrote: > -------------------------------------------------- > ----- > > > > It doesn’t matter what the floating rate is > > because you’ve contracted yourself into a > window > > which will always contain your effective loan > rate > > (in this case the window only contains the one > > value becuase the strike rate is the same for > > floor/cap). > > > Except this part is just not true. A zero cost > collar might be long a 9% cap and short a 1% floor > or something. That means your LIBOR bond is, uh, > essentially a LIBOR bond unless interest rates > move a ton. Floating within a range doesn’t mean > a fixed rate bond. I think whoever wrote this > question needs to think about the zero-cost collar > some more. Agree in reality, but they set this up in CFA fantasy land and specified the strike rate be the same on the floor/cap (note they said the collar has a zero value…not a zero cost collar), so that the window which ordinarily would be have a range (like 1-9% in your example) essentially forces it to behave exactly like a fixed bond. Absurd? Yes, but it does force you into that answer.