Alolo has bought from YoBank a 3 versus 6 Forward Rate Agreement which is based on a notional principal amount of USD 5 million and an agreed rate of 2% per annum. At the start of the FRA period, the actual rate of interest is 1.5% per annum. Explain what will take place at the start of the Forward Rate Agreement period and calculate the reimbursable amount, assuming a 360-day year
Alolo has bought from YoBank a 3 versus 6 Forward Rate Agreement which is based on a notional principal amount of USD 5 million and an agreed rate of 2% per annum. At the start of the FRA period, the actual rate of interest is 1.5% per annum.
Explain what will take place at the start of the Forward Rate Agreement
period and calculate the reimbursable amount, assuming a 360-day year.
Forward rate agreement: It refers to an interest rate hedging strategy where parties agree to settle the loss in a forward futures contract at the contract’s expiration date. The profit/loss from the contract is based on the difference in the agreed settlement price & the spot price on the expiration date.
At the start of the FRA period, Ayola will buy a contract from YoBank in order to hedge the loss from the interest rate changes. At the start of the contract, the actual rate is less than the agreed rate due to which Ayola is at a loss.
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