Go AD-Free with CAclubindia Pro and Daily Mobile Updates. Subscribe Now!

Problem regarding FRA topic of SFM for CA final?

Sangita gupta (final Student) (312 Points)

30 October 2010

In May 2010 New syllabus exam one question appears from Arbitrage in FRA (Forward rate Agreement).

I devoted so much time to understand the solution of suggested But i can't understand.

My question is:

1. What is FRA? and

2. How a person can made Arbitrage in FRA?

Can any one clarify if in simple language.

I am waiting for your valuable reply. thanks

Reply
Follow
Share

8 Replies

Tanvi Bansal (Article) (26 Points)
Replied 30 October 2010

forward rate aggrement means agreement with bank to purchase the foreign currency at a future date on a predetermined price.

for ex:-a person enter into a contract with bank on 30.10.2010 to purchase $1at RS. 50/- on 01.10.2011

1 Like

Sangita gupta (final Student) (312 Points)
Replied 30 October 2010

Tanvi you are explaining forward exchange rate but i am asking about Forward Rate Agreement.

For your information:

Forward Rate agreement(FRA) is different froam Forward exchange rate.

Thanks

1 Like

CA Puneet Roopchandka (Senior Consultant) (99 Points)
Replied 30 October 2010

A forward rate agreement (FRA) is a forward contract in which one party pays a fixed interest rate, and receives a floating interest rate equal to a reference rate (the underlying rate). The payer of the fixed interest rate is also known as the borrower or the buyer, whilst the receiver of the fixed interest rate is the lender or the seller. The payments are calculated over a notional amount over a certain period, and netted, i.e. only the differential is paid. It is paid on the effective date. The reference rate is fixed one or two days before the effective date, dependent on the market convention for the particular currency. FRAs are over-the counter derivatives. A swap is a combination of FRAs.

Many banks and large corporations will use FRAs to hedge future interest rate exposure. The buyer hedges against the risk of rising interest rates, while the seller hedges against the risk of falling interest rates. Other parties that use Forward Rate Agreements are speculators purely looking to make bets on future directional changes in interest rates.

The netted payment made at the effective date are as follows

The Fixed Rate is the rate at which the contract is agreed.

The Reference Rate is typically Euribor or LIBOR.

α is the day count fraction, i.e. the portion of a year over which the rates are calculated, using the day count convention used in the money markets in the underlying currency. For EUR and USD this is generally the number of days divided by 360, for GBP it is the number of days divided by 365 days.

The Fixed Rate and Reference Rate are rates that should accrue over a period starting on the effective date, and then paid at the end of the period (termination date). However, as the payment is already known at the beginning of the period, it is also paid at the beginning. This is why the discount factor is used in the denominator.

for better understanding u can refer SD BALA

1 Like

CA Nagendra (CA) (1788 Points)
Replied 31 October 2010

Originally posted by : Sangita gupta
	In May 2010 New syllabus exam one question appears from Arbitrage in FRA (Forward rate Agreement). I devoted so much time to understand the solution of suggested But i can't understand. My question is: 1. What is FRA? and 2. How a person can made Arbitrage in FRA? Can any one clarify if in simple language. I am waiting for your valuable reply. thanks

You will get your answer from the attached file. please read it once.

All the concept of FRA and Arbitrage in FRA has been explained in simple language.

you can understand the FRA concept only if you know about the Implied forward rate. it is also explained in this file.

Attached File : 6 summery otc derivatives.pdf downloaded: 706 times

7 Like

Sangita gupta (final Student) (312 Points)
Replied 01 November 2010

Thanks a lot sir for sharing .................

I have no word to explain it...............

Himani Sharma (CA Final) (142 Points)
Replied 01 November 2010

@ Nagendra

Thanks for sharing such a good notes................................

Ankit Jain (Article (Final)) (110 Points)
Replied 02 November 2010

Thanks for sharing your notes.

Vivek Himalaya (Student) (160 Points)
Replied 11 January 2011

@ Nagendra sir,

In this notes you have explained only Forward rate agreement.

When you upload the notes for Interest rate swap (topic from OTC Derivative) ? in November 2010 there was 16 marks question from this topic. will you provide this notes.

Your notes for Forward rate agreement is really very good.

thanks for you afford.