FRA

AMITAG1990
Finance Junkie
Posts: 89
Joined: Sat Sep 22, 2012 12:35 pm

FRA

Postby AMITAG1990 » Fri Nov 09, 2012 5:11 pm

Consider a Forward Rate Agreement which receives a rate of 8%, annually compounded, on a premium of $100 between the end of year 1 and year 2. Find out the value of the FRA using the additional information provided in the following table (given rates are continuously compounded):
Spot of 2 yr=6% and forwrd of 2nd Yr = 7%
Choose one answer.
a. $886920 Incorrect
b. $1000000 Incorrect
c. $750000 Incorrect
d. $665190 Correct
The correct answer is $665190.
Forward rate is 7% at the year end 2 compounded continuously. Equivalent annually compounded rate = 7.25%.
Value of bond = $100million*(0.08 – 0.0725)e-0.06*2 = $665,190

In this value of FRA has been calculated at the time of 0 Yr. but as per my understanding FRA value should be calculated at the starting of FRA period here which is at the end of 1 yr. please make me clear.

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balajismz
Finance Junkie
Posts: 63
Joined: Mon Nov 05, 2012 9:13 am

Re: FRA

Postby balajismz » Fri Nov 09, 2012 5:20 pm

Nope, the solution is right, FRA starts from T1 and ends at T2, but while valuing an FRA you would need to bring it back to current date or calculate the PV at time 0.

Balaji

AMITAG1990
Finance Junkie
Posts: 89
Joined: Sat Sep 22, 2012 12:35 pm

Re: FRA

Postby AMITAG1990 » Fri Nov 09, 2012 5:41 pm

but how can we calculate its value at zero, if i talk practially at zero yr we cann't know the LIBOR of 1yr After 1yr.. So In books also they use to calculate it at the starting of FRA.

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

Re: FRA

Postby swarnendupathak » Fri Nov 09, 2012 9:38 pm

I think Amit is right, in valuing FRA it is discounted to time period of T1 not to T Zero, as we don't know the future discount rate. The answer should be 706323/-

If i am wrong please make it clear.

Swarnendu


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