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A "three against nine" FRA has an agreement rate of 4.75 percent. You believe six-month LIBOR in three months will be 5.125 percent. You decide to take a speculative position in a FRA with a $1,000,000 notional value. There are 183 days in the FRA period. Determine whether you should buy or sell the FRA and what your expected profit will be if your forecast is correct about the sixmonth LIBOR rate.

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tahneetakhan

Answer:

Yes you should buy the FRA

Expected Profit = $1,858

Explanation:

Since the agreement rate is less than your forecast, you should buy a FRA.

Hence, If your forecast is  correct your expected profit will be:

$1,000,000 x [(0.05125-0.0475) x 183/360] / [1 + (0.05125 x 183/360)]

= $1,000,000 x [.001906/(1.026052)]

= $1,857.61.

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