Suppose a company expects to receive $10,000,000 in 2 months time, but does not need to use the funds until 5 months time. So the company would like a forward deposit from 2 months to 5 months, and a bank offers a 2-month forward rate agreement on the 3-month rate with FRA rate of 1.42%. 

(a) What is the key risk for the company? 

(b) What FRA position, pay fixed or receive fixed, does the company require? 

(c) If the 3-month market rate in 2 months time is 1.4%, what is the payoff from the FRA in 5 months’ time? 

(d) Show that entering into a FRA allows the company to lock in the forward deposit rate of 1.42%. You will need to account carefully for all the cash flows.

Answer rating: 100% (QA)

a The key risk for the company is the interest rate risk specifically the risk of interest rates moving unfavorably between 2 months and 5 months In t... View the full answer