NVESTOPEDIA EXPLAINS 'INTEREST RATE COLLAR'

An interest rate collar can be an effective way of hedging interest rate risk
associated with holding bonds. Since a bond's price falls when interest rates go
up, the interest rate cap can guarantee a maximum decline in the bond's value.
While interest rate floor does limit the potential appreciation of a bond given a
decrease in rates, it provides upfront cash to help pay for the cost of the ceiling.
Let's say an investor enters a collar by purchasing a ceiling with a rate of 10%
and sells a floor at 8%. Whenever the interest rate is above 10%, the investor will
receive a payment from whoever sold the ceiling. If the interest rate drops to 7%,
which is under the floor, the investor must now make a payment to the party that
bought the floor.