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CA Final · Advanced Financial Management · Interest Rate Risk Management

Kaveri Industries buys a 3x9 FRA from a bank for a notional principal of ₹10,00,00,000 at an FRA rate of 7.00% p.a. The contract period is 180 days and a 360-day year is used. At settlement, after 3 months, the reference rate is 8.00% p.a. The settlement is made at the start of the contract period, so the interest differential is discounted at the reference rate. What is the settlement amount?

Kaveri receives ₹4,80,769. The reference rate exceeds the FRA rate by 1%, giving a differential of ₹5,00,000 for half a year. Because settlement happens at the start of the period, this is discounted at 1.04, which gives ₹4,80,769.

  1. AKaveri receives ₹4,80,769Correct
  2. BKaveri pays ₹4,80,769
  3. CKaveri receives ₹5,00,000
  4. DKaveri receives ₹9,25,926

Explanation

The reference rate (8%) is higher than the FRA rate (7%), so the buyer receives. Settlement = 10,00,00,000 × (0.08 − 0.07) × 180/360 ÷ (1 + 0.08 × 180/360) = 5,00,000 ÷ 1.04 = ₹4,80,769. Receiving ₹5,00,000 ignores the discounting, because the payment is made at the start of the period instead of its end.

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