Page 28 - FINAL CFA II SLIDES JUNE 2019 DAY 10

LOS 39.a: Describe and compare how equity, interest rate,
fixed-income, and currency forward and futures contracts are READING 39: PRICING AND VALUATION OF FORWARD COMMITMENTS
priced and valued.
LOS 39.b: Calculate and interpret the no-arbitrage value of
equity, interest rate, fixed-income, and currency forward and MODULE 39.4: PRICING FORWARD RATE AGREEMENTS
futures contracts.

To price/value an FRA, view the contract as a commitment to lend or borrow at a certain interest rate at a future date.

Notation: 2 × 3 FRA is a contract that expires in two months (60 days), and the underlying loan is settled in three months (90 days).

Pricing FRAs – 3 things to remember:
1. LIBOR rates in the Eurodollar market are add-on rates
and are always quoted on a 30/360 day basis in annual
terms. For example, if the LIBOR quote on a 30-day
loan is 6%, the actual unannualized monthly rate is 6%
× (30/360) = 0.5%.

2. The long position in an FRA is, in effect, long the rate
and benefits when the rate increases.

3. Although the interest on the underlying loan won’t be
paid until the end of the loan, the payoff on the FRA
occurs at the expiration of the FRA (e.g., in two months).
The underlying Therefore, the payoff on the FRA = PV of the interest
rate is 1-month savings on the loan.
(30-day) LIBOR
on a 30-day loan
in 60 days. 4. The forward “price” in an FRA is actually a forward
interest rate.