Question

Question 10.1-- (RCB) Royal Canada Bank needs to borrow $ 10 million in three months for a nine-month period. it buys a " three against twelve" FRA for $10 million at a rate of 8% to hedge its exposure. In three months the FRA settles at 7.5%. There are 273 days in the FRA period. What is the bank's net borrowing cost for the 273 days ( at an annualized rate)?

Choices: a) 7.25% b) 7.50% c) 7.75% d) 8.00%

10.2- A firm needs to invest $2,000,000 three months from today for three months.. Which of the following is a correct strategy to hedge its interest rate exposure?

Choices:

a.. Buy an FRA that is comparable in maturity with the planned investment..

b.. Sell an FRA that is comparable in maturity with the planned investment..

c.. Buy Eurodollar futures contracts that are comparable in maturity with the planned investment..

d.. Enter a swap that the firm pays floating and receive fixed..   

10.3) A firm buys “ three against six ” FRA at 7.5% (aannualized)) with the notional principal of $2 million. On the settlement date, the interest rate in the market is 9%. How much is the firm cash settlement for the FRA?? ( Assume dtm is 91 days..)

Answer 1

10.1- d) 8%. In this case since the borrower has enetered into FRA at the rate of 8% for 273 days. hence effective interest rate is locked at 8% for the borrower on the start date.

10.2- b.. Sell an FRA that is comparable in maturity with the planned investment. Since the company has to lock in its invetsment rate. it has to sell FRA that is comparable in maturity with the planned investment.

10.3- Settlement amount = Principal amount * FRA rate - LIBOR * no of days in period no of days in year 1+ LIBOR rate * no of days in period no of days in year