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option interest rate options may be arranged for longer periods and Interest rate options can alternatively be used as a means of financial speculations. but All options involve the payment of a premium, often upfront which is payable whether or not the option is exercised. They are expensive to buy, particularly when interest rates are volatile.One of the main disadvantages of interest rate option so far discussed is the payment of premium. Even if interest rate caps and floors are useful in hedging long-term interest ratemovement, they are very expensive to use. If a company doesn’t want to pay high premium, butwish to hedge its interest rate risk, the alternative it has is to use interest rate collars option. Aninterest rate collar option reduces the premium cost by limiting the possible benefits of favorableinterest rate movement. A collar involves the simultaneous purchase and sale of options. Forinstance, when a borrower buys a collar, he is buying cap at one strike rate but at the same timeis selling a floor at a lower rate. Hence, the cost of a collar is the difference between the premiumpayable on the cap and the premium receivable from selling the floor. If the cost of the cap isoffset exactly by the sale value of the floor, then the collar is known as a zero cost collar.
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