FRA Question

d2syh
Good Student
Posts: 21
Joined: Fri Aug 17, 2012 3:27 pm

FRA Question

Postby d2syh » Thu Nov 08, 2012 3:11 pm

Suppose you traded a FRA of value (approx.) $7165 for the period between 3 to 6 months on a principal of $1mn. The spot rate for 6 month LIBOR is 5% and FRA pays 10% (quarterly compounding). Find out 3 month LIBOR spot rate.
Choose one answer.
a. 3%
b. 7%
c. 5%
d. 2.5%
The correct answer is 3%.
Value = $1mn *(.1 - Rfwd)*(0.5 – 0.25)*e-(0.5)*0.5 = 7165
Rfwd = 0.706 = 0.05 + (.05 – r)*(1/(2-1))
r = .0299 = 3%

Pls explain ...
Is discount factor e^-0.05*0.5 being used?

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swarnendupathak
Finance Junkie
Posts: 119
Joined: Mon Sep 17, 2012 11:06 am

Re: FRA Question

Postby swarnendupathak » Thu Nov 08, 2012 3:35 pm

Yes, the discount factor of 0.05 for 6 months with continuous compounding was used here...I think the rfwd is a quarterly compounding rate, hence to calculate the 3 months spot rate we need to modify it to continuous compounding as 6-month libor is continuous compounding.
Please make me correct if i am wrong.

Swarnendu

content.pristine
Finance Junkie
Posts: 356
Joined: Wed Apr 11, 2012 11:26 am

Re: FRA Question

Postby content.pristine » Fri Nov 09, 2012 5:38 pm

Thats right swarnendu.
That is nothing but the discount factor
8-)


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