Question #4 - Reading 30 Pricing and Valuation of Forward Commitments

Reading: Reading 30 Pricing and Valuation of Forward Commitments

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Shared Context

- Which forward rate agreement would most effectively hedge Vetements Verdun's exposure to LIBOR? A) 3 x 2. B) 2 x 5. C) 2 x 3.

Question

Which value is closest to the price of the most effective hedge for Vetements Verdun?

Answer Choices:

A. 3.3%

B. 3.6%

C. 3.0%

Explanation

The actual, unannualized rate on the 60-day loan is: R60 = 0.028 × 60/360 = 0.00467 The actual, unannualized rate on the 150-day loan is: R150 = 0.033 × 150/360 = 0.01375 So the rate on a 90-day loan to be made 60 days from now is: FR (60,90) = ((1 + R150)/(1 + R60)) − 1 FR (60,90) = (1.01375/1.00467) − 1 FR (60,90) = 1.00904 − 1 FR (60,90) = 0.904% We annualize this rate using the formula: 0.904% × (360/90) = 3.62% (Module 30.4, LOS 30.c) Typesetting math: 100%

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