# Interest rate collar

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## Interest rate collar

It is a transaction between you and the bank that determines the acceptable interval of the maximum and minimum variable interest rates (e.g. Euribor 3m, Euribor 6m) for agreed period of time. The bank pays compensation to you in case the interest rate exceeds the highest level chosen by you, and you pay an additional amount to the bank in case the interest rate becomes lower than the minimum level calculated on the transaction date.

• Effective way to determine the maximum and minimum interest rates for the entire loan period
• No one-off premium is usually applicable
• Minimum transaction amount EUR 1 million

## Risks

After an agreement has been acquired, the paid premium is not refunded (if was paid).
For instance, if market interest rates will be below minimum variable rate for longer period, in case of an interest rate collar buyer would incur a loss.

These transactions are concluded over-the-counter; therefore, under certain circumstances in the market, the market value of fixed-term or interest rate collars may be subject to higher volatility. For this reason, where the concluded interest rate collar is sold on the market, or where an offsetting transaction is used for closure, the market value of the transaction may be unfavourable to the party to the transaction.

## Example

Let us suppose that you concluded an interest rate collar on 1 January 2021

Basic terms
Transaction amount EUR 1 million
Expiration time 5 years
Maximum variable interest rate chosen by you (EURIBOR 6M) 0.1,0%
Minimum variable interest rate calculated by the bank 0.50%

On 1 July 2021, EURIBOR 6M stands at 0.60%.
The amount due to the bank from you (the difference between the minimum interest rate calculated on the transaction date and the actual market interest rate:
1,000,000 x (0.60 — 0.50) x 180 / 360 = EUR 500

On 1 January 2022, EURIBOR 6M reaches 1.20%.
The amount due to you from the bank (the difference between the maximum interest rate chosen on the transaction date and the actual market interest rate):
1,000,000 x (1.20 — 1.00) % x 180 / 360 = EUR 1000

The same principle applies to the calculation of other payments until the completion of the transaction, i.e. until 1 January 2026