What is a zero-cost collar in FX hedging?
A core Corporate Treasury interview question — asked in analyst and associate interviews across IB, PE, and the Big 4.
THE SHORT ANSWER
A zero-cost collar combines buying a put option and selling a call option with the same expiration and net zero premium. The put sets a floor on the exchange rate, protecting against adverse moves, while the sold call caps the upside if rates move favorably. The premium from the call offsets the put premium. It's used to hedge forecasted FX exposure at no upfront cost, but limits potential gains. The trade-off is protection versus opportunity cost; it's suitable when the company wants costless hedging but can accept a limited range.
WHAT INTERVIEWERS LISTEN FOR
- ✓Buy put, sell call, net zero premium
- ✓Provides floor and cap
- ✓Costless but limits upside
COMMON MISTAKES
- ✗Thinks it's a forward
- ✗Ignores the cap on upside
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