Collar hedge and Price risk: Difference between pages

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imported>Doug Williamson
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imported>Doug Williamson
m (Spacing, wiki bulleting and category added 21/8/13)
 
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<i>Risk management</i>.
Price risk is the risk that the value of an investment that you own will fall.


This risk illustrates how risks interact, as price risk could be caused by some or all of:


1.
* Interest rate risk – interest rate fluctuations affect the value of instruments which pay fixed interest.
* Credit risk – the asset is worth less because the issuer’s credit standing has weakened.
* Market liquidity risk – the market is only willing to buy the asset at a lower price (if at all).


Two options used in combination as a hedge for an underlying exposure to a market price.
Price risk shows how risks can be bundled up into a single term in some applications, and how important it is that the treasurer understands how risks originate.
Collar hedges are more complex structures, compared with a simpler cap option or floor option.


An advantage of collars for hedging is that they reduce the net premium paid for the hedge.  They do this by adding a short option position to the long position in the simple cap or floor.  
Although a single term can be useful when considering an asset or liability class, it can also confuse.


In other words the hedger <i>sells</i> an option (in addition to <i>buying</i> the simple cap or floor option).
The terminology tends to be driven by symptoms rather than causes, and a risk management strategy should really be driven by the causes.




The premium received by the hedger reduces their net premium payable.  The net premium payable is often zero. (This arrangement is called a <i>zero cost</i> collar.)
== See also ==
 
* [[Credit risk]]
It is also possible - though less common - to construct a <i>negative cost</i> collar, the net premium being <i>receivable</i> by the hedger.
 
 
The case where the hedger <i>pays</i> a net premium for the collar is known as a <i>positive cost</i> collar.


The result of dealing in the combination of two options as a hedge is to ‘collar’ the all-in hedged expense or income achieved within a range which is acceptable to the hedger.
[[Category:Financial_risk_management]]
 
Collars are also known as <i>cylinders</i>, <i>corridors</i> or <i>range forwards</i>.
 
 
2.
 
The net hedged profile achieved by the use of the two options, in combination with the underlying exposure.
 
 
== See also ==
* [[Cap]]
* [[Floor]]
* [[Interest rate collar]]
* [[Negative cost collar]]
* [[Positive cost collar]]
* [[Zero cost]]

Revision as of 12:24, 21 August 2013

Price risk is the risk that the value of an investment that you own will fall.

This risk illustrates how risks interact, as price risk could be caused by some or all of:

  • Interest rate risk – interest rate fluctuations affect the value of instruments which pay fixed interest.
  • Credit risk – the asset is worth less because the issuer’s credit standing has weakened.
  • Market liquidity risk – the market is only willing to buy the asset at a lower price (if at all).

Price risk shows how risks can be bundled up into a single term in some applications, and how important it is that the treasurer understands how risks originate.

Although a single term can be useful when considering an asset or liability class, it can also confuse.

The terminology tends to be driven by symptoms rather than causes, and a risk management strategy should really be driven by the causes.


See also

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