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Collar Agreement – Definition

Collar Agreement Definition

A collar agreement is a popular method to lock-in a given scope of possible return outcomes or by hedging risks. A collar is a well-known financial strategy to limit the potential outcomes of an uncertain variable to an acceptable range. The largest failing of a collar is restricted upside and the price drag of transaction expenses. For some strategies, a collar serves as an insurance policy exceedingly overcomes the extra fees.

A range of values gets set adequately with a ceiling or cap and a floor by a collar, such as risk levels, market value adjustments, and interest rates. Collar potential has no limit with all the securities, options, derivatives, and futures available now.

A Little More on What is a Collar Agreement

When dealing with equity securities, a collar agreement provides a range of share quantities that will be proposed for acceptance by the seller and buyer that assures they are getting their expected deals or a range of amounts within which a stock will be valued. The main collar types are fixed share collars and fixed-value collars.

In a merger and acquisition deal, a collar could protect the buyer from substantial fluctuations in the price of the stock from the time the merger starts to the time it is complete. When mergers aren’t financed with cash but stock instead, collar agreements get used, which can be dependent on adjustments in the stock’s price and have an impact on the value for both the buyer and seller.

It’s possible that the options strategies are the most extravagant of all. In this capacity, a collar involves an extended position in an underlying stock with the purchase of protective puts at the same time along with the sale of the call options against that holding. The calls and puts are out-of-pocket-money options that have an identical expiration month and they both must be same as the number of contracts. A collar strategy of this kind is comparable to an out-of-the-money covered call strategy with an additional protective put purchased. When an options trader favors generating premium income from writing covered calls, however, wants to protect the downside from a sharp price drop unexpectedly of the underlying security, a collar strategy is often the approach.

References for Collar Agreement

Academic Research on Collar Agreement

Agreement on intimate partner violence among a sample of blue-collar couples, Cunradi, C. B., Bersamin, M., & Ames, G. (2009). Journal of interpersonal violence, 24(4), 551-568.

The Pricing of Default‐free Interest Rate Cap, Floor, and Collar Agreements, Briys, E., Crouhy, M., & Schöbel, R. (1991). The Journal of Finance, 46(5), 1879-1892. This paper addresses the valuation of collars, floors, and caps in a conditional claim design under continuous time. The instruments are explained as options of coupon bonds on traded zero. The prices of the bonds are used as the underlying hypothetical variables. This way, we end up with solutions that are closed form and simple to compute. Special focus is dedicated to the decision of the stochastic method suitable for the price dynamics of the underlying zero coupon bonds.

Sitting in judgment: The sentencing of white-collar criminals, Wheeler, S., Mann, K., & Sarat, A. (1988).

Collars and renegotiation in mergers and acquisitions, Officer, M. S. (2004). The Journal of Finance, 59(6), 2719-2743.The author analyzes the effect of and motivation for involving a collar in a merger agreement. The most significant cross-sectional arguments of the structure for the bids are the market-related standard deviations of stock return for the target and bidder. The author presents evidence in line with the hypothesis that the process of payment is contingent on the target and bidder’s sensitivities to market-related risk because both have the motivation to request renegotiation of the terms for the merger if the amount of the offer from the bidder changes substantially proportionate to the value of the target within the bid period.

Recent innovations in interest rate risk management and the reintermediation of commercial banking, Brown, K. C., & Smith, D. J. (1988). Financial management, 45-58. An up-and-coming development has been the production of products and procedures created to control the exposure of interest rate for a corporate client. Yet, the banking system’s role is not fully accepted. This article debates that commercial banks are correctly considered an intermediary between options and futures exchanges and the eventual user of the hedging product.

Path dependent options: The case of lookback options, Conze, A. (1991). The Journal of Finance, 46(5), 1893-1907. Lookback option contingent claims are path-dependent of which the extrema of a specific security’s price over a given period of time determine the payoffs. We extract clear-cut formulas for different European lookback options with the use of probabilistic tools and offer outcomes regarding their counterparts in America.

Managing M&A Risk with Collars, Earn‐outs, and CVRs, Caselli, S., Gatti, S., & Visconti, M. (2006). Journal of Applied Corporate Finance, 18(4), 91-104. Merger and acquisition transactions subject the target shareholders and the bidder to many significant risks before the deal closes and during the phase of post-close integration. The primary risk prior to closing is the likelihood that stock price fluctuations of target and bidder will impact the terms of the deal and lower the possibility of the deal closing. The primary post-close risk for the bidder shareholders is the lack of success in the target performing up to expectations, which then could lead to overpayment. This article describes various tools useful in managing these risks with many examples to illustrate the pricing and structure of the tools. Offers with collars can secure target shareholders from a dip in share prices of the bidder company in the case of pre-closing risks and acquirers have protection from excessive dilution.

Pattern bargaining: an investigation into its agency, context and evidence, Traxler, F., Brandl, B., & Glassner, V. (2008). British Journal of Industrial Relations, 46(1), 33-58. This article is an empirical and analytical offering to the debate of pattern bargaining. Theoretically, the authors provide a framework that facilitates analysis to methodically separate definite examples of pattern bargaining relative to function, scope, development, and agency, which come out of contrasting contexts relative to economic conditions, power relations, and interest configuration. The authors use the framework to create provable hypotheses on pattern bargaining as an instrument of inter-industry bargaining co-ordination. Empirically, they test the hypotheses for collective bargaining in Austria from 1969 to 2004.

Insider trading in derivative securities: An empirical examination of the use of zero-cost collars and equity swaps by corporate insiders, Bettis, J. C., Lemmon, M., & Bizjak, J. (1999). The authors offer an analysis of using zero-cost collars and equity swaps by corporate insiders hedging the associated risks of their individual holdings in the equity of the company. Both these financial instruments have significant overtone for incentive-based contracts and insider trading.  The authors suggest from their examination that these activities usually involve CEOs, senior executives, and board members and span more than a third of their equity holdings. They discover that hedging transactions are initiated immediately after large price run-ups, prior to announcements of poor earnings, and before volatility of stock prices increase.

The market pricing of implicit options in merger collars, Officer, M. S. (2006). The Journal of Business, 79(1), 115-136. Nearly 20 percent of stock-swap merger bids include collars which impact the amount the target shareholders receive. The author contends that collar bids offer two causes of value to the target: the value of the definite options of the collar and the basic offer premium. Hypothesizing that the market should estimate both value sources definite in the bid for the collar merger, the author finds the market prices for both the option value and offer premium are the same by valuing the implicit collar options. This outcome suggests market participants are aware of the underlying of the merger agreements and implies the offer elements are substitutable.

•    A bargaining approach to currency collars, Lien, D., & Moosa, I. (2004). Research in International Business and Finance, 18(3), 229-236. The authors follow a bargaining process to analyze the operational hedging approach of currency collars. They use two companies with risk tolerance variances and with simulation results demonstrate the technique of defining the risk sharing threshold. The authors discovered that both companies profit from a currency collar as long as one firm is further risk-averse than the other firm.

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