Question

A Forward Rate Agreement contains an agreed interest rate of 3.1% on a 6-month loan. If settled at the time of borrowing, what amount would the borrower pay or receive on a $500,000 loan if the prevailing 6-month interest rate is 2.9%?

a) $1000 payment

b) $1000 receipt

c) $972 payment

d) $972 receipt

Please show formula and how to do calculations. Thanks!

Answer 1

Answer is C

FRA agreed rate = 3.1% (6 months rate)

It means that, borrower is agreeing to pay 3.1% for the loan he will take in future.

At the time of borrowing, rate = 2.9%

So borrower is in loss since he has to pay more interest than the market rate

Principal amount = 500,000

So borrower needs to pay at the end of the loan = 500,000 * (3.1 - 2.9 ) / 100 = 1000

But this amount the borrower has to pay after the loan period is over.

But we need to calculate the amount at the time of borrowing or when FRA expires

So we need to find present value ( 6 months present value ) of 1000 at market rate

So = 1000 / ( 1.029) = 971.8 = 972 payment

LET ME KNOW IF YOU HAVE ANY DOUBTS

PLEASE RATE THUMBS UP IF YOU LIKE THE ANSWER