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CA Final · Advanced Financial Management · Interest Rate Risk Management

Anand Motors will borrow Rs 5 crore for 3 months starting 3 months from now and has bought a 3 x 6 FRA at 7.20% p.a. When the FRA settles, the 3-month reference rate is 6.40% p.a. Which statement about the outcome is correct?

Anand pays the bank. An FRA buyer gains when the reference rate rises above the agreed rate and loses when it falls below it. Since the reference rate of 6.40% is below the agreed 7.20%, Anand pays the differential, offsetting its cheaper borrowing.

  1. AAnand receives from the bank because rates fell
  2. BAnand pays the bank because the reference rate is below the agreed rateCorrect
  3. CNo payment arises because the loan is a floating rate loan
  4. DAnand pays the bank only if the actual loan rate equals the agreed rate

Explanation

The FRA buyer receives when reference exceeds the agreed rate and pays when reference is lower. Here 6.40% < 7.20%, so Anand pays the differential (0.80% x 3/12 x 5 crore = Rs 1,00,000 before discounting). The actual loan is cheaper, so the net effective cost still equals about 7.20%. The first option confuses the direction.

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