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Just done the mock exam, and could not remember what to do with the FRA, looking at the answer I am even more confused – I understand the concept that it is fixing the rate to borrow in the future, what I do not understand is the 5.75 – 5.50 etc. and the answer, I get the 1/4 is for the time.
Is the question asking if the FRA rates change or if the actual rates change.
On the answer why is the 34,375 a minus figure? What is the calc doing? Is it always for one quarter?- Topics: 1
- Replies: 87
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Hi Karen,
First of all, we are hedging the risk of a change in the actual underlying loan rate – the FRA rate does not change. So, whatever happens to the actual loan rates in the question the adjustments made in accordance with the terms of the FRA ensure that the company only ends up paying the rate agreed in advance, under the FRA.
The FRA solution in the Mock follows a fairly “standard” approach to calculating the payment required under the FRA, either to the bank ($34, 375) or from the bank to the company ($6,250).
The actual loan and the FRA are two separate contracts, often agreed with two different banks. The FRA payment is designed to compensate the company if the actual interest rate agreed on the loan rises above the rate agreed under the FRA. The logic is vice versa if the actual loan rate has fallen below the FRA.
Regards, Kevin Kelly
Ok, just like a buy & sell rate where the buy rate (borrowing) will always be larger?
- Topics: 1
- Replies: 87
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Hi Karen,
Yes, this is correct. 5.75, the Higher rate is for a future borrowing requirement (for locking into a fixed rate of interest for the period of the loan)
5.25, the Lower rate is for a future lending requirement (for locking into a fixed rate of interest for the period of the deposit)
Regards, Kevin Kelly
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