An Interest Rate Collar is a relatively low-cost interest rate risk management strategy that uses derivatives to hedge an investor's exposure to interest rate fluctuations. The key components of an interest rate collar are two Interest Rate Swaps (IRS), with different notional values and maturities, but with the same underlying reference asset. One IRS is used to cap the maximum interest rate exposure, while the other is used to floor the minimum exposure.The main benefit of an interest rate collar is that it provides protection against large swings in Interest rates, without having to pay the full premium for an outright swap contract. This makes it a more cost-effective solution for investors who are looking to mitigate their risk in a volatile market environment.There are some drawbacks associated with this strategy, however. First and foremost, it does not protect against moderate changes in Interest rates - only extreme moves up or down from the current level. Additionally, if rates move lower than the floor price set by the investor's short position in swaps, they will actually incur a loss on their investment portfolio.
