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CA Final · Advanced Financial Management · Interest Rate Risk Management

Which statement about a Forward Rate Agreement is correct?

An FRA is settled in cash on the difference between the agreed rate and the reference rate applied to a notional principal. The principal itself is not exchanged, there is no obligation to lend or borrow, and it is an over-the-counter contract rather than an exchange-traded one.

  1. AIt is settled in cash based on the difference between the agreed rate and the reference rate, applied to a notional principalCorrect
  2. BThe notional principal is exchanged between the parties on settlement
  3. CIt obliges the buyer to actually borrow from the seller at the agreed rate
  4. DIt is an exchange-traded standardised contract with daily margining

Explanation

An FRA is an OTC contract settled in cash for the interest differential on a notional principal. The principal is never exchanged and no actual loan is required. It is not exchange-traded or margined daily like futures.

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