A Coupon Collar is a feature attached to a Floating Rate Note (FRN) that sets a minimum and maximum limit on the interest payment (the “coupon”) an investor can receive. Think of it as putting bumpers on a bowling lane for your investment income. The coupon rate can move up and down with a benchmark interest rate, like SOFR, but it will never go above a certain ceiling (the cap) or fall below a certain safety net (the floor). This structure is created using two derivative instruments: the issuer buys an interest rate cap to protect itself from skyrocketing rates, and the investor simultaneously gets the protection of an interest rate floor. The goal is to provide a degree of certainty for both the bond's issuer (who knows their maximum payment) and the investor (who knows their minimum income). It's a trade-off: in exchange for a guaranteed minimum payment, the investor gives up the potential for unlimited gains if interest rates soar.
A collar elegantly solves two problems at once by establishing a “corridor” for interest payments. It's composed of two parts: a cap and a floor, which are essentially two separate option contracts bundled with the bond.
Imagine you own an FRN that pays SOFR + 1.0%. The issuer adds a coupon collar with a 3% floor and a 7% cap. Here’s how your coupon payment would adjust:
Collars exist because both parties to a loan—the lender (investor) and the borrower (issuer)—crave predictability.
A value investor should view a coupon collar with healthy skepticism. While the floor seems like a wonderful safety feature, it’s never free. The price you pay for that downside protection is the cap, which limits your upside potential. The key question is always: What am I getting for what I'm giving up? A value investor's primary defense is the margin of safety—buying an asset for significantly less than its intrinsic value. While a coupon floor provides a margin of safety for income, it may come at the cost of your total return. If you believe interest rates are at a cyclical low and are likely to rise, an uncapped FRN might be a far more attractive investment, as you would participate fully in the rising rates. A collared bond isn't inherently good or bad. Its value depends entirely on the price paid, the specific levels of the cap and floor, and your own well-researched outlook on the future of interest rates. Sometimes, the security of the floor is well worth the capped upside, especially if the bond is purchased at a steep discount. As always, the answer lies in the numbers, not the narrative.
Think of a coupon collar like a smart thermostat for your home's heating system.
The temperature (the coupon rate) can fluctuate within this 18-22°C range, but it will never go outside those pre-set boundaries. You get comfort and cost control, but you give up the “option” of making your house extra toasty on a particularly cold day.