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CA Final · Advanced Financial Management · Interest Rate Risk Management

Narmada Power Ltd plans to borrow ₹20,00,00,000 for 90 days, starting 3 months from now, at MIBOR + 1.00% p.a. It buys a 3x6 FRA at 6.50% p.a. on the same notional (360-day year, 90-day period). At settlement, MIBOR is 7.50%. The FRA settlement is received at the start of the loan and is invested at 7.50% for the 90 days. Ignoring any bank fees, what is Narmada's effective annualised interest cost on the ₹20 crore loan?

The effective cost is 7.50% p.a. The FRA gain of about ₹4.91 lakh, invested at 7.5%, grows to ₹5 lakh and cuts the ₹42.5 lakh interest to ₹37.5 lakh. That equals the locked FRA rate of 6.5% plus the 1% spread on the loan.

  1. A7.50%Correct
  2. B8.50%
  3. C6.50%
  4. D8.00%

Explanation

FRA settlement = 20,00,00,000 × 0.01 × 90/360 ÷ (1 + 0.075 × 0.25) = 5,00,000 ÷ 1.01875 ≈ ₹4,90,798. Invested at 7.5% for 90 days, it grows to ₹5,00,000. Loan interest = 20 crore × 8.5% × 0.25 = ₹42,50,000. Net interest = 42,50,000 − 5,00,000 = ₹37,50,000, which is 7.5% annualised. This equals the FRA rate of 6.5% plus the 1% spread. An answer of 8.5% ignores the FRA gain.

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