Skip to content

ACCA Strategic Professional · Advanced Financial Management · The use of financial derivatives to hedge against interest rate risk

Kestrel plc buys a 3v9 FRA on $8 million at a fixed rate of 4.00%. At settlement, the reference rate is 5.00%. Ignoring discounting, what is the amount of the FRA payment before settlement adjustment, and who pays?

The bank pays Kestrel $40,000. The market rate of 5% exceeds the agreed 4%, so the FRA buyer gains. The difference of 1% on $8 million for six months is $40,000, before any discounting to the settlement date.

  1. A$40,000 paid by the bank to KestrelCorrect
  2. B$40,000 paid by Kestrel to the bank
  3. C$80,000 paid by the bank to Kestrel
  4. D$80,000 paid by Kestrel to the bank

Explanation

Rate difference is 1.00%. Over 6 months: 8,000,000 x 1.00% x 6/12 = $40,000. The reference rate exceeds the fixed rate, so the buyer receives. $80,000 ignores the half-year fraction.

Did you get it right without looking?

One question tells you little. A timed set on The use of financial derivatives to hedge against interest rate risk shows your real accuracy, how long you take and where you lose marks.

Practise The use of financial derivatives to hedge against interest rate riskFree diagnostic mock

More The use of financial derivatives to hedge against interest rate risk questions