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

Zeta plc will borrow $20 million in 3 months for 6 months at a floating rate and wants to fix its borrowing cost now. Which instrument most directly fixes the rate for this future borrowing with no ability to benefit from favourable rate moves?

A bought 3v9 forward rate agreement fixes the rate on a 6-month loan starting in 3 months. It is binding, so the borrower gains no benefit from falling rates, unlike options or caps, which keep the upside.

  1. ABuying a 3v9 forward rate agreementCorrect
  2. BBuying a put option on an interest rate futures contract
  3. CBuying an interest rate cap on the borrowing
  4. DEntering a receive-fixed pay-floating swap

Explanation

A 3v9 FRA, bought by the borrower, fixes the rate for a 6-month period starting in 3 months and locks in the rate whatever happens. A cap sets a maximum but allows benefit from falling rates. A put option on futures gives a protection right, not a fixed rate. A receive-fixed swap would worsen exposure for a floating borrower.

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