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Premium-reduction device
       
 
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Premium-reduction device

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Premium-reduction device
A strategy that aims to reduce the cost of an Option or other Derivative. There are many ways to achieve this; three common techniques follow.
The first is to sell a second Derivative; the Premium received can then be used to lower the funding requirement for the purchased Derivative. This is the technique employed for reducing the cost of a Collar.
The second is to Limit participation in moves in the Underlying by imposing limitations on the payout profile of the instrument (as in a barrier Option or a Capped floater).
The final way is to accept payments below market rates, with the possibility of making up the shortfall at the end of the instrument’s life (see Yield adjustment).
Posted by  Privatebanking.com
 
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