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CMA Final · Strategic Financial Management · Interest Rate Derivatives

Hindustan Components Ltd buys a 3x6 FRA from a bank on a notional principal of Rs 10 crore at an agreed rate of 7% p.a. On the settlement date (start of the 3-month period) the reference rate is 8% p.a. Use a 3-month fraction of 0.25 year and discount the settlement at the reference rate. What is the settlement?

The FRA buyer receives about Rs 2,45,098 from the bank. The reference rate is above the agreed rate, so the buyer gains. The interest difference of Rs 2,50,000 is paid at the start of the period, so it is discounted at 1.02.

  1. ABank pays Hindustan Components about Rs 2,45,098Correct
  2. BHindustan Components pays the bank about Rs 2,45,098
  3. CBank pays Hindustan Components Rs 2,50,000
  4. DBank pays Hindustan Components about Rs 2,45,700

Explanation

The reference rate (8%) exceeds the FRA rate (7%), so the buyer receives. Undiscounted amount = 10,00,00,000 x 1% x 0.25 = Rs 2,50,000. The FRA is settled upfront, so discount by (1 + 0.08 x 0.25) = 1.02, giving Rs 2,45,098. Rs 2,50,000 ignores discounting; Rs 2,45,700 discounts at the wrong rate (7%).

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