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ACCA Strategic Professional · Advanced Financial Management · The use of financial derivatives to hedge against interest rate risk

A treasurer expects to borrow $10 million in 3 months for a period of 6 months and wants to fix the borrowing rate now. Which instrument is designed to do this?

The company should buy a 3v9 forward rate agreement. The loan starts in three months and runs six months to month nine. Buying the FRA locks in the borrowing rate and pays compensation if market rates rise. Selling it would suit a depositor.

  1. AA 3v9 forward rate agreement bought by the companyCorrect
  2. BA 3v9 forward rate agreement sold by the company
  3. CA 6-month interest rate swap receiving fixed
  4. DA 9-month interest rate floor purchased

Explanation

The borrowing starts in 3 months and ends in 9 months, so a 3v9 FRA is needed. A borrower buys the FRA, which pays out if rates rise above the agreed rate. Selling the FRA would protect a depositor, not a borrower. A floor protects against falling rates.

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