FRM Part I · FRM Exam Part I · Properties of Interest Rates
A company enters an FRA as the borrower, with a notional of USD 10 million, an FRA rate of 5.00% (simple, annual basis) on a 6-month period starting in 6 months. At settlement, the 6-month reference rate is 6.00%. Using the convention that settlement occurs at the start of the interest period, what is the payoff to the company?
The company receives about USD 48,544. As the FRA borrower it gains when the reference rate of 6% exceeds the 5% FRA rate. The undiscounted difference is USD 50,000, which is discounted by 1.03 because settlement occurs at the start of the period.
- AUSD 50,000 received
- BUSD 48,544 paid
- CUSD 50,000 paid
- DUSD 48,544 receivedCorrect
Explanation
Borrower receives when the market rate exceeds the FRA rate. Interest difference = 10,000,000*(6%-5%)*0.5 = 50,000. Settled at the start of the period, it is discounted: 50,000/(1+0.06*0.5) = 48,544 received. The 50,000 option ignores discounting.
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