Module 49.2: Forward Rate Agreements and Swap Valuation

Question 1

What is a forward rate agreement?

Answer 1

derivative contract that has a future interest rate, rather than an asset, as its underlying.

Question 2

What is a synthetic FRA?

Answer 2

when you borrow for 120 days at day one and lend the proceeds for 30 days.

Question 3

What is the largest difference between forwards and futures from a valuation perspective?

Answer 3

futures gains and losses are settled each day and the margin balance is adjusted accordingly. Forwards do not require or provide funds in response to fluctuations.

Question 4

Why would the value of futures and forwards slightly differ if interest rates and prices are positively correlated?

Answer 4

the reinvestment income from funds received from the future will be higher.

Question 5

In a forward rate agreement who is considered to be “long” or “short”

Answer 5

long pays fixed rate and received LIBOR (floating).

will receive LIBOR - fixed rate
or pay
fixed rate - LIBOR

Question 6

Why is a interest rate swap equivalent to “off market” FRA?

Answer 6

because in 1 year swap, the fixed rate is the same for each payment period, but if you go to a market and get an FRA, the fixed rates would be different for each period.

Question 7

In order to replicate an interest rate swpa with zero value at initiation what must the present value of all synthitc FRA’s equal to?

Answer 7

zero