A 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’snet borrowing cost for the 273 days (at an annualized rate)?
FRA payment = ((( R- FRA)* P* t)/ 273)*(1/(1+R*(t/273)))
Where P is the amount of the contract, R is the floating rate, FRA is the fixed rate and t is the time period of contract.
First lets understand how to calculate Forward rate agreement:
Net borrowing cost= ((( 8%- 7.5%)* 10000000*90)/ 273)*(1/(1+ 8%*(90/273)))
= 1648351.65* 0.9743= 1605989.01
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