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CA Final · Advanced Financial Management · Interest Rate Risk Management

Sundaram Textiles Ltd expects to borrow Rs 10 crore for 6 months starting 3 months from today and wants to protect against a rise in interest rates. Which FRA position fits this need, and what does the notation '3 x 9' describe?

The borrower should buy the FRA, because it receives a payment if market rates rise above the agreed rate. The 3 x 9 notation means the contract period begins 3 months from today and ends 9 months from today, so it covers 6 months.

  1. ABuy a 3 x 9 FRA; the loan starts in 3 months and the FRA period ends 9 months from today, so the covered period is 6 monthsCorrect
  2. BSell a 3 x 9 FRA; the loan starts in 3 months and the FRA period ends 9 months from today, so the covered period is 6 months
  3. CBuy a 3 x 9 FRA; the loan starts in 9 months and runs for 3 months
  4. DSell a 3 x 9 FRA; the loan starts in 3 months and runs for 9 months

Explanation

A borrower fears rising rates, so it buys an FRA, which pays when the settlement rate exceeds the agreed rate. In a 3 x 9 FRA, 3 is the months to start and 9 the months to end, giving a 6-month period. Selling the FRA suits a lender worried about falling rates, so option B is wrong.

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