Schweser Book 4 clarification expected, reference, agreement, 120

Howd

"Page: 120 - Clarification
In a FRA agreement the value to the manager is LIBOR - reference rate. In this question LIBOR moved against the manager and went down instead of going up as the manager had expected. Since we know LIBOR decreased the manager will owe the bank and the bank bears the credit risk. The reference rate and LIBOR were switched in the answer to show a positve number indicating the manager owed the bank that amount. Also, at initiation of an FRA the reference rate could be equal to either LIBOR or LIBOR plus the spread. In the example on page 90, at initiation of the FRA, LIBOR equals the reference rate thus the 200bps spread is not used in the answer. Conversely on page 115 Q10 since the reference rate is 5% and LIBOR was initially 3.5% at initiation of the FRA the spread would need to be added to LIBOR so that at initiation the 150 bps spread + 3.5% LIBOR = 5% reference rate. Since the spread was used at initiation of the contract this requires using the 150 bps spread in the answer (3% + 150bps = 4.5%) explanation as shown on page 120. ( Posted: 2011-01-03) "

What does this even mean? Now I'm confused....because it says the FRA reference rate can be LIBOR or LIBOR + spread. Isn't the reference rate FIXED?

Does this mean the payoff is LIBOR + spread - reference rate???



Edited 1 time(s). Last edit at Thursday, May 26, 2011 at 02:52PM by Eazy E.

oneboy

The reference rate drove me crazy and I finally gave up on this FRA. It's not in the curriculum, the example and questions interprete the reference rate differently. Knowing the concept could be good enough for the exam, I doubt a whole AM question is for it.

former

I don't know why schweser used an FRA example. I didn't see FRA being mentioned on CFAI text. So I'm skipping it