Explanation:
In a Forward Rate Agreement (FRA), the company has agreed to pay a fixed rate of 5.0% and receive the floating rate (90-day LIBOR). Since the actual LIBOR rate (6.0%) is higher than the fixed rate (5.0%), the company will receive the difference.
$10,000,000Payment formula for FRA settled in advance:
\text{Payment} = \frac{\`$10`,000,000 \times (0.06 - 0.05) \times 0.25}{1 + 0.06 \times 0.25} \text{Payment} = \frac{\`$10`,000,000 \times 0.01 \times 0.25}{1 + 0.015} \text{Payment} = \frac{\`$25`,000}{1.015} = \`$24`,630.54 \approx \`$24`,631Since the company receives the payment (floating rate > fixed rate), the correct answer is Company receives $24,631.
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A company wants to borrow $10 million for 90 days starting in one year. To hedge the interest rate risk of the future borrowing, the company enters into a forward rate agreement (FRA) where the company will pay a fixed rate, R(k), of 5.0%. The FRA cash settles in one year; i.e., in advance (T=1.0) not in arrears (T=1.25). All rates are expressed with quarterly compounding. If the actual 90-day LIBOR observed one year forward turns out to be 6.0%, what is the cash flow payment/receipt by the company under the FRA?
A
Company pays $24,631
B
Company pays $25,000
C
Company receives $24,631
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