Could someone please explain to me why/how we discount the interest savings/losses on FRAs. For instance, in an Elan reading, the interest rate savings/losses at expiration for a 1x5 FRA are discounted back 120 days while the value of a 1x5 FRA at day 20 is determined by discounting the interest savings/osses back 130 days. Anyone know why?
Thanks
As S2kmagician always says when in Doubt always draw graph.
Draw graph. You’ll have better idea.
As you’ve already moved 20 days into the FRA(gone) and now only 10 days left to expire the FRA you’ve to Discount it back the Loan period, which was originally of 120 days, to the current position to value FRA prior to maturity i.e 120 days + 10 days of FRA= 130 days.
FRAs use something like LIBOR which are add on rates… so when it expires it is what a loan or borrow would be at the end of the loan period so you have to discount it back to present value terms using the rate in place on the expiration date