Skip to content

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

Which statement about forward rate agreements is correct?

An FRA is an over-the-counter contract where only the net interest difference on a notional principal is settled. No loan is actually made, and the buyer is bound either way, so it cannot benefit from favourable rate moves like an option can.

  1. AAn FRA is an over-the-counter contract settled by paying only the net interest difference, with no loan of the principal.Correct
  2. BAn FRA obliges the buyer to borrow the notional principal from the bank at the agreed rate.
  3. CAn FRA allows the buyer to benefit if rates fall, since it is like an option.
  4. DAn FRA is a standardised exchange-traded contract with daily margin payments.

Explanation

FRAs are OTC agreements tailored to the customer's amounts and dates. Only the difference between the agreed and reference rates is settled on the notional principal. Unlike options, they are binding both ways, so gains from falling rates are lost; and they are not exchange traded.

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