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in part (b) how to do the calculation ? what does v stands for ?? and which interest rate should be taken ?
v doesn’t actually stand for anything 🙂
What 3 v 4 means is that the interest rates apply to loan or deposits starting in 3 months time and finishing in 4 months time (i.e. 1 month in total).
Similarly, 3 v 7 means that the interest rates apply to loans or deposits starting in 3 months time and finishing in 7 months time (so for 4 months in total).The reason that there are two interest rates quoted is that the lower one is the rate you will receive if you are depositing money, and the higher one is the rate that you will pay if you are borrowing money.
In all cases the interest rates are quotes as annual rates, even though they will only be calculated for the preiod of the loan/deposit.
The ways that FRA’s work is that when the loan starts, you will be charged the actual interest rate on that date. (So if it is a 4 month loan and the interest rate is 7.76% p.a. then the interest will be 4/12 x 7.76% x the amount of the loan. This interest will usually be payable at the end of the loan.)
However, because you have an FRA (for a 4 months loan starting in 3 months – i.e. 3 v 7 – the interest fixed will be 7.53% p.a.) the bank will pay you back the difference – 7.76% – 7.53% = 0.23% x 4/12 x the amount of the loan. (This repayment will usually be made at the date the loan starts).As a result, the net interest you pay is effectively fixed at 7.53% p.a. – the amount quoted in the FRA.
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