Skip to content

CA Final · Advanced Financial Management · Interest Rate Risk Management

Arjun Industries wants to hedge a Rs 50 crore borrowing for months 6 to 12. The market gives a 6-month rate of 6% p.a. and a 12-month rate of 7% p.a. (simple interest, annualised). Which is the approximate theoretical 6x12 FRA rate, using simple interest on a 360-day basis with 6 months = 0.5 year?

The theoretical 6x12 FRA rate is about 7.77% p.a. Divide the 12-month growth factor 1.07 by the 6-month growth factor 1.03 to get 1.038835, giving 3.8835% for six months, which annualises to 7.77%.

  1. A7.77% p.a.Correct
  2. B8.00% p.a.
  3. C7.00% p.a.
  4. D7.28% p.a.

Explanation

Growth over 12 months = 1 + 0.07 = 1.07. Growth over 6 months = 1 + 0.06 x 0.5 = 1.03. Forward growth = 1.07/1.03 = 1.038835. Subtract 1 = 0.038835; annualise by dividing by 0.5 = 7.767%, i.e. 7.77%. Option 8.00% is the naive 2x7 - 6 subtraction, which ignores compounding of the first period.

Did you get it right without looking?

One question tells you little. A timed set on Interest Rate Risk Management shows your real accuracy, how long you take and where you lose marks.

Practise Interest Rate Risk ManagementFree diagnostic mock

More Interest Rate Risk Management questions