do we have to know how to calculate SWAP and FRA?

CFA Level I Derivatives
#1

Hi,

I came across a few exercices in the mocks where it was demanded to calculate a price of swaps and fras. I didn’t see any LOS going in that sense… what about you guys?

there’s a question where we have to calculate a FRA… I’d like to know this calculation, but in the curriculum, it’s pretty “unclear” (IMO)

#2

It is good for you to know it, it can come in handy.

Forward rate adgreent is a future swap contract between two parties.

Say party A agrees with party B to borrow $1,000 30 days from now at 6%. If the actual 60 days floating rate (LIBOR) is say 7%, then we can calculate the FRA as follows.

Step1.

Since Party A can borrow at 6% as against the floating rate of 7%, he benefits from the agreement, and thus his gain is calculated as follow.

(7%-6%)*(60/360)*1,000 = 1.67

Step2.

Discount 1.67 using the LIBOR adjusted for periodicity.

1.67/{1+(1%*(60/360)} = 1.667.

So get cracking down on it.

I hope this helps.

#3

Thanks this was quite helpful and something I was seeking an explanation on.

#4

Isn’t the price of FRA the fixed rate you agree in the contract ? Like in the example olajideanuoluwa001 gave, shoudnt the price be 6%?

Also in the example why did you discount 1.67? I thought you made payments as and when the period occurs?

#5

http://www.wikinvest.com/wiki/Forward_Rate_Agreement

#6

ok so let’s learn this… aargh

#7

Yes, i already made the correction in my ealier post, the fixed rate is 6%.

The price agreed by both party is 6%, but at the end, the rate increased to 7%, and thus party A can borrow at the lower rate of 6%, so party A benefits.

Based on the assumptions of FRA, because its a forward rate, we have to discount it using the actual LIBOR rate to get the PV.

#8

my process up there is just the simplest i have seen so far. Learnt it from the Schweser note.

#9

I still didnt get why you took the PV. The cash settlement happens when the loan period starts. So when you get to know the actual LIBOR (7% in this case), the cash settlement takes place. So why discount it?

#10

I didn’t remember that Schweser gave an example of a FRA calculation?!

#11

Yeah me too. Can you please share the page number?

#12

Btw, this reminds me. I have almost exclusively been studying from schweser. Did you guys find something in the curriculum which has been omitted in schweser?

#13

At Level I you need to know how to calculate the value of an FRA at expiration, not the price of an FRA. (The price of an FRA is the fixed rate.)

I wrote an article on FRAs that may be of some help here: http://financialexamhelp123.com/fras/

#14

Thanks 2000magician. Your article cleared things up.

#15

Good to hear.

#16

Yea, S2000magician already helped me out there with his article.

Thank you Magician

#17

My pleasure.