Page 239 - Microsoft Word - 00 CIMA F1 Prelims STUDENT 2018.docx

Answers to examples

Chapter 13

Example 1

Q (a company) wishes to borrow £2.5 million in five months, for a period of
nine months. A bank has quoted the following (Forward Rate Agreement) FRA
rates:

5 v 14 3.55 – 3.70

Q can borrow at 0.50% above base rate, and the base rate is currently 2.50%.
Concerned that base rates may rise, Z decides to take the FRA offered by the
bank.

At the settlement date for the FRA, base rate has risen to 3.50%.

What is the effective interest rate paid by Z, for its borrowing?

(Answer in %, to 2 decimal places).

Solution

The reference rate of 3.50% is lower than the FRA rate of 3.70% (banks
charge higher rate of interest on borrowing) so the FRA will be settled by a
payment by Q of 0.20%.

The actual rate paid on the loan is 4.00% (base plus 0.50%), and adding the
FRA payment of 0.20% gives an effective rate of 4.20%.

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