Exact Matches:
COLLAR
The simultaneous purchase of an out-of-the-money call and sale of an out-of-the-money put (or cap and floor in the case of interest rate options). The premium from selling the put reduces the cost of purchasing the call. The amount saved depends on the strike rate of the two options. If the premium raised by the sale of the put exactly matches the cost of the call, the strategy is known as a zero cost collar. When used to hedge an outright position in the underlying, this locks the hedger into a range of values; this hedging strategy is known as a cylinder.
Partial Matches:
ACCRETING
A description, applicable to a variety of instruments, denoting that the notional principal increases successively over the life of the instrument, e.g., caps, collars, swaps and swaptions. If the increase takes place in increments, the instrument may be known as a step-up.
See also
amortizing
AMORTISING
A description, applicable to a variety of instruments, denoting that the notional principal decreases successively over the life of an instrument, e.g., amortizing swap, index amortizing rate swap, amortizing cap, amortizing collar, amortizing swaption. If the decrease takes place in increments, the instrument may be known as a step-down. Mortgage-style amortization refers to an amortizing swap such that the principal amortization plus interest is the same amount in each interest period.
See also
accreting
COLLAR SWAP
A collar on the floating-rate leg of an interest rate swap. The transaction is zero cost – the purchase of the cap is financed by the sale of the floor. The collar constrains both the upside and the downside of a swap.
COLLARED FLOATER
A floating-rate note whose coupon payments are subject to an embedded collar. Thus the coupon is capped at a predetermined level, so the buyer forsakes some upside, but also floored, offering protection from a downturn in the reference interest rate. Also known as a mini-max floater.
GUARANTEED RETURN ON INVESTMENT
Any instrument (usually a structured note) which guarantees investors a minimum return on their investment. This can be achieved by combining a debt issue with a structure, such as a collar or cylinder, which locks gains into a range. This means that the investor gains protection from an adverse market move by limiting participation in any favorable move.
See also
principal-guaranteed note
IMPACT FORWARD
A collared forward, such as one in which the purchaser buys a put and sells a call, both being out-of-the-money. The premiums on the two options balance out, so the strategy is zero cost. Upside and downside is limited to the gap between the strike prices.
See also
collar
MANDARIN COLLAR
The Mandarin Collar combines a range forward with the purchase of a range binary structure, such that should the spot stay within the prescribed range, the proceeds of the range forward are enhanced by the pay-out amount of the range binary. If either of the limits trades at any time, the range binary is terminated, but the underlying exposure remains hedged by the range forward. The graph displays the payoff of a long exposure hedged using a Mandarin Collar; the choice of name should be apparent from this picture.
MIN-MAX
London Metal Exchange vernacular for a collar – selling an option, in order to fund the purchase of an opposite option.
PREMIUM-REDUCTION DEVICE
A strategy which aims to reduce the cost of an option or other derivative. There are many ways to achieve this; three common techniques follow.
The first is to sell a second derivative; the premium received can then be used to lower the funding requirement for the purchased derivative. This is the technique employed for reducing the cost of a collar.
The second is to limit participation in moves in the underlying by imposing limitations on the pay-out profile of the instrument (as in a barrier option or a capped floater).
The final way is to accept payments below market rates, with the possibility of making up the shortfall at the end of the instrument’s life (see yield adjustment).
WEATHER DERIVATIVE
Typically swaps and vanilla options such as calls, puts, caps, floors and collars with payoffs linked to temperature, precipitation, humidity or wind speed. Most instruments are linked to heating degree days or cooling degree days. These two indexes measure the deviation of the average of a day’s high and low temperature from a baseline reference temperature.