Final answer:
An interest rate collar is a financial derivative that involves taking a long position in an interest rate cap or floor and a short position in the other, which is a true statement. This strategy is used to manage interest rate risks by setting a range for potential interest rate fluctuations.
Step-by-step explanation:
The statement that an interest rate collar is a combination of a long position in either a cap or a floor with a short position in the other is true. An interest rate collar is a risk management tool used in finance to limit exposure to interest rate fluctuations. This financial instrument is typically used by investors or institutions who have a liability or asset sensitive to changes in interest rates.
A long position in an interest rate cap gives the purchaser the right, but not the obligation, to borrow at a maximum interest rate, protecting them from rising rates. Conversely, a long position in an interest rate floor gives the purchaser the right to lend at a minimum interest rate, safeguarding them against falling rates. The short position in the opposite instrument (cap or floor) involves selling this protection to another party, which helps offset the cost of purchasing the first instrument and establishes a range within which the interest rate will fluctuate.
In essence, the collar strategy limits both the potential benefit and risk for the user, by setting a cap on potential high rates while also setting a floor for potential low rates. It's a trade-off between cost and protection that allows a party to manage their interest rate risk in a controlled manner.