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  1. Dear Mr John.

    in regard to P4 acca December 2013 Qn 2 (Awan Co). in FRA, when the rate increases from 4.09% by 0.9%, the 20 basis has been reduced, (rate used in soln is 4.79%=4.09%+0.9%-0.2%)

    but in the second part where by rate is decreasing by 0.9% from 4.09% the soln shows that 20 basis were note reduced (rate used on 4.09%-0.9%=3.19%)

    why is 0.9% not reduced in finding the second rate?

  2. when bank quote FRA, the FRA rate is refer to LIBOR rate or the total borrowing rate of company?

    Because i refer to BPP text book, the FRA is refer to LIBOR so it make me confuse.

    for eg, the company can borrow at LIBOR (currently is 4%) + 1%, if the FRA rate is 5.5 %,
    which mean the effective interest rate is 5.5% or 6.5%?

  3. In forward rate agreements, would we not pay a premium to the bank like in the case of interest rate guarantee ?
    And then what is the difference between both of the hedging options?

    Please let me know.

    • A premium is paid to the bank only when you opt for an option. With FRA, the borrower and bank agrees on a fixed interest rate and do not have the option to exercise (when interest rate is unfavourable)or allow it to lapse (when interest rate is favourable).

      You only receive a compensation from the bank when the prevailing (transaction date) interest rate increase above agreed (fixed) interest rate. Conversely, you pay the bank a compensation when the prevailing interest rate is lower than the agreed interest rate.

      With IRG, you have the flexibility to exercise or allow the option to elapse based on the change of the interest rate. Hence you are required to pay a premium to the bank.

      In the nutshell, we would not pay a premium to the bank under FRA.

  4. the terms cap and floor seem redundant in the sense that when i buy a put option when i want to borrow, i am, by default putting a cap. and thus “traded caps” and “traded floors” are the same as traded options for put and traded options for calls respectively.

    wd this be a correct way to summarize caps and floors?

    • The trade date is the date we arrange the FRA. The spot date is when the arranging is finalised (usually 2 days after the trade date, but this is not a fixed rule). The fixing date is usually 2 days before the settlement date ( the date the loan starts) and is the day when the payment to be transferred if fixed.

      I would be very surprised if you were tested on these terms in P4 – it is not that sort of exam.

  11. In the FRA agreement example the difference is setteled with the bank at the start of the loan and interest would be payble at the end.

    For loans with longer time periods the difference in timing might have a significant effect, would we have to take into account this when calculating the effective interest? Or is it unlikely to be asked of us in the exam?

    • @htung00, That is usually the case (settle at the beginning and interest at the end) but it really depends on the agreement with the bank. It is unlikely to be relevant in the exam (it never has been!) but it would be good to mention it if you get the chance.

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