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CA Final · Advanced Financial Management · Interest Rate Risk Management

Bharat Logistics will draw a ₹20 crore loan in 3 months for a 3-month period, at floating 3-month MIBOR plus 1% p.a. To fix its cost, it buys a 3x6 FRA at 8.00% p.a. on ₹20 crore. At the reset date MIBOR is 9.00% p.a. Ignoring discounting of the FRA settlement and any day-count differences, what is the effective annualised borrowing cost after the FRA?

The effective cost is 9.00%. The loan costs MIBOR plus 1%, which is 10%, but the FRA pays the company 1% (9% less 8%). The net cost is therefore the FRA rate of 8% plus the 1% spread, whatever MIBOR turns out to be.

  1. A9.00%Correct
  2. B10.00%
  3. C8.00%
  4. D11.00%

Explanation

The loan costs 9% + 1% = 10%. The FRA pays the company 9% − 8% = 1% on the notional. Net cost = 10% − 1% = 9%, which equals the FRA rate of 8% plus the 1% spread. ₹10% ignores the FRA gain, 8% ignores the spread, and 11% treats the FRA gain as a loss.

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