Derivatives: Interest rate Cap,Floor and collars

[cfa_ candidate_ 2011]

Greetings
Interest Cap,Floor and collars went over my head , i just don't understand what they actually are.
As i remember from readings( i think its bond or equity) a floor will enable option write to pay at least that interest rate if interst rate goes down and cap will protect the option write to to pay only the interest rate if intrest rate goes really high.

But now, here is the dilema for me: CFAI text mentions that "combination of interst rate call is a cap", and "combination from interest rate put is interest rate floor"

I just couldn't able to imagine how a combination of interest rate call would be an interest rate cap.

Also what is this collar? A combination of interest rate caps and floors? what exactly does it mean?

I woul really appreciate, if anyone can explain this concept to me.

Thank you.

 

[sdevine42]

I just finished reading that section for the first time earlier this week, so please anyone correct me if I state anything incorrectly. My understanding is that the cap is a series of interest rate call options with expirations that coincide with your interest payments. Since the calls will have a positive return when rates rise, this increase will offset your increase in costs associated with your interest payments - thus “capping” your interest payments in a way. The same but opposite holds true with floor/puts.
For the collar, you go long either floor or cap and then short the other. The short provides cash inflow to offset the long. For example, long the cap to offset a rise in interest rates and short the floor to pay for it. The result protects from a rise in interest rates, but you now have sacrificed your benefit if rates fall.
Hope this helps.