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Dear John
First of all is there any formula to calculated estimated FRA based on Ytm?If yes please elaborate kindly.
Secondly The technical article on Determing FRA and their application to SWAP valuation why the interest rate based on annual spot yield curve of Year 2 is compounded and divided by the compound interest rate of year 1 to find the FRA of year 2?
Am i correct that the Above calculation give FRA for year 2 or not as i am a bit confused by the comment on the article which is ”The interest forward commencing in one year time for a borrowed sum lasting year would be 5.71%.The 12v24 FRA =5.71%.
I got the 12v 24 FRA as i would be borrowing in 12 months time and my loan would be lasting for 12 months if i am not wrong.
What does it mean by lasting for one year?
Thankssorry for opening another thread on this.Hope you understand.But the Queries are different though .Thank you.
No – sorry – it is not learning a formula 🙁
A 12v24 FRA is an interest rate fixed now to apply in the second year (i.e. starting in 12 months and finishing in 24 months – so lasting one year.)
What we are trying to work out is what would the interest rate in the second year which would make borrowing for 1 year at the 1 year spot rate and then borrowing for a second year at the FRA rate, equal to borrowing for 2 years at the 2 year spot rate.
(They are not going to borrow for all of two years – they are only going to borrow for that second year – but the bank will do the above arithmetic to arrive at an FRA rate to quote for the second year.)Just suppose someone did borrow 100 for 2 years. At the end of 2 years they would owe 100 x (1.046^2) = 109.4116
Suppose instead they borrow the 100 for 1 year (at 3.50%) and then borrowed the total again for a second year at the rate for the second year (lets say it is R).
After two years they would owe 100 x 1.035 x (1 + R)
if you make this equal to 109.4116 then 100 x 1.035 x (1+R) = 109.4116
So R = 0.0571 of 5.71%So anyone wanting to borrow month in 1 years time for 1 year will be quoted a rate by the bank of 5.71%
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