Treasury Management

Forward Rate Agreements

Hand-out Questions 5

1. The current yield curve is:

Term(days) Yield(%p.a.)
90 8.65
180 8.95
270 9.25
a) What is the 180-day rate 90 days ahead?
b) In 90 days we will need to borrow $1m for 180 days. Explain the following hedging devices
and outline the advantages and disadvantages of each one.
i) Money market transactions
ii) Bank bill futures
iii) Another hedging instrument
c) Should you hedge? What do you get out of hedging?

2. The current yield curve is:

Term(days) Yield(%p.a.)
90 19.90
180 19.30
270 18.80
a) Find the forward rates in this yield curve.
b) The bill futures price for a contract settling in 180 days is fixed at 83.75. A bank issues a
180/270 FRA with a guaranteed rate of 15% p.a. Identify an arbitrage opportunity, and
determine the overall profit from this position the rate on settlement date (in 180 days) is:
i) 14% p.a.
ii) 20% p.a.

3. In May 2012, a bank will issue a 4/7 FRA referenced to BBSW with a guaranteed rate
of 4.5% p.a.. Bank bill futures for September 2012 delivery are priced at 95.75.
Assume there are no transaction costs and no spread between FRA borrowing and
lending rates, and 30-day months.
i) Identify a strategy based on one futures contract which will yield an arbitrage
profit, and
ii) Demonstrate how this will be achieved and calculate the net gain (or loss) from
this strategy if the 90-day bank bill rate turns out to be 6% in September 2012.

4. With reference to question (3), explain how the presence of an arbitrage opportunity
will lead to the enforcement of the ‘Law of One Price’.
5. On December 5th 2011, Alison was advised by her bank that her application for a bill
acceptance facility that would allow her to issue 120-day bank bills with a total face
value of $850,000 in June 2012, was successful. These will be sold to yield
BBSW+0.5% p.a. Concerned that interest rates may rise before the bills are issued on
June 5th, Alison assembled the following FRA quotations payable against the reference
rate of BBSW.
FRA Lender Borrower
6/9 5.5% p.a. 6.5% p.a.
6/10 5.6% p.a. 6.6% p.a.
9/12 5.9% p.a. 6.9% p.a.
10/13 6.0% p.a. 7.0% p.a.
Clearly state how Alison should use an FRA to hedge her exposure, and calculate the
amount, direction, and date of the payment at settlement if, on the settlement date
BBSW is 5.1% p.a.

Date of activity FRA activity Physical market activity