Question

A bank needs to hedge a 6-month gap in 6 months. They need to profit if rates fall. Should the bank buy or sell an FRA? What rate are they trying to hedge?

The amount they need hedged is $50,000,000. The rate they’re hedging against is currently 2%. On the settlement date, the rate ends up at 1.75%. Did the bank win or loss on this FRA? By how much?

[SHOW STEPS AND CALCULATION]

Answer 1

Bank needs to hedge in 6 months. They need to profit, if rates fall.
So, they should Sell FRA.
Amount hedged =	$50,000,000.00
Rate for hedging = 2%
on settlement date, rate = 1.75%
FRA is short. Short is at 2%, buying or settlement is at 1.75%.So profit on Sale = Agreement rate - settlement rate
2%-1.75%
0.25%
Amount received on FRA = Hedged amount * net interest gain * no. of months/12
50000000*0.25%*6/12
$62,500.00
So, Bank will win on FRA, as amount received on FRA is $62,500.