Can someone please explain what the following instruments are and how they work - it is not at all clear to me an interest rate future buying a put option on an interest rate (this apparently caps the rate for future borrowing - but cannot understand how/why!) buying a call option on an interest rate (collars the minimum rate for future lending - but again cannot understand how/why this is) thanks
think that a specified principal applies on the interest rate in all cases, e.g. If you have a loan of 100m and you pay floating interest rate on it, if you buy a call on the floating interest rate with exercise rate 5%, it provides a payoff if the floating interest rate is more than 5%. e.g. if on expiry the floating rate is 6%, the payoff will be 100m x (6%-5%)= 100m x 1% So if you add this to your loan interest payment of 100m x 6% in total you get -100m x 6% +100m x 1% = -100m x 5%
