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

Orlo Co buys a 6v12 FRA on €12 million at 3.00%. At the start of the FRA period the reference rate is 4.00%. The FRA settles at the start of the period, with the payment discounted at the reference rate for the 6-month period. What is the settlement receipt?

Orlo receives €58,824. The undiscounted difference is 1% on €12 million for half a year, €60,000, but because settlement is at the start of the period, it is discounted by 1 plus 4% times six-twelfths, which is 1.02.

  1. A€58,824Correct
  2. B€60,000
  3. C€57,692
  4. D€120,000

Explanation

Undiscounted payment = 12,000,000 x 1% x 6/12 = €60,000. Discounting at 4% for 6 months: 60,000 / (1 + 0.04 x 6/12) = 60,000/1.02 = €58,824. €60,000 is undiscounted. €57,692 uses 1.04.

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