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CFA Level I · CFA Level I Exam · Pricing and Valuation of Forward Contracts and for an Underlying with Varying Maturities

A long FRA was initiated at a contract rate of 3.0%. Some time later, the forward rate for the same underlying period has fallen to 2.6%. The current value of the long position is most likely:

The long position now has a negative value. The long pays the fixed contract rate of 3.0% and receives the floating rate, which is expected to be only 2.6%. The expected shortfall, discounted to the present, is a loss to the long position.

  1. Azero, because an FRA has no value after initiation.
  2. Bpositive, because the long position receives the lower rate.
  3. Cnegative, because the long position pays a fixed rate above the market forward rate.Correct

Explanation

The long FRA gains when rates rise because it receives the floating rate and pays the fixed contract rate. With the forward rate at 2.6% and the contract rate at 3.0%, the long position pays more than it expects to receive, so its value is negative (the present value of about 0.4% on the notional adjusted for the period). The FRA is worth zero only at initiation, not afterwards.

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