A financial manager needs to hedge against a possible decrease in short-term interest rates. He decides to hedge his risk exposure by going short on an FRA that expires in 90 days and based on 90-day LIBOR. The current term structure for LIBOR is given in Table 1 below.
- Identify the type of FRA used by the financial manager using the appropriate terminology.
- Calculate the rate the manager would receive on this FRA.
- It is now 30 days since the manager took a short position in the FRA. Interest rates have shifted down, and the new term structure for LIBOR is given in Table 2 below. Calculate the market value of this FRA based on a notional principal of $15,000.000.
| TABLE 1: TODAY | |
| Term (days) | LIBOR spot |
| 30 | 5.83% |
| 90 | 6.00% |
| 180 | 6.14% |
| 360 | 6.51% |
| TABLE 2: 30 days later | |
| Term (days) | LIBOR spot |
| 60 | 5.50% |
| 150 | 5.62% |
| 180 | 5.75% |
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