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FRM Part I · FRM Exam Part I · Interest Rates

A treasurer expects to borrow USD 10 million in three months for a period of three months and fears that rates will rise. Which position in a forward rate agreement (FRA) on the three-month rate, starting in three months, hedges this exposure?

The treasurer should buy the FRA, paying fixed and receiving floating. If rates rise, the floating amount received exceeds the fixed amount paid, and the gain offsets the higher cost of the planned borrowing, which locks in the borrowing rate.

  1. ABuy the FRA, which means paying the fixed rate and receiving the floating rateCorrect
  2. BSell the FRA, which means receiving the fixed rate and paying the floating rate
  3. CBuy the FRA, which means receiving the fixed rate and paying the floating rate
  4. DSell the FRA, which means paying the fixed rate and receiving the floating rate

Explanation

A future borrower loses when rates rise. The FRA buyer pays the fixed rate and receives the floating rate, so if the floating rate rises above the fixed rate the FRA payoff offsets the higher borrowing cost. Selling the FRA would add to the loss, because it gains only when rates fall.

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