SS 14 FRA credit risk

jbaldyga

On pages 90-91 of schweser book 4, study session 14, the example states that you must discount back the payment of the FRA based on the loan amount.

Here is the question:

In anticipation of brooiwing $1mm at LIBOR +200 bps for one year, a manager has entered an FRA with a reference rate of 5% and a notional principal of $1mm. it is now three months before the maturity of the FRA, which coincides with the beginning of the loan, and LIBOR has increased to 6%. assuming the risk free rate is 4% determine the value and direction of any credit risk in the FRA.

they are saying that the manager is entitled to a $10k payment, which makes sense but then says that this amount must be discounted back 1 year at 8% (6%(LIBOR)+200bps).

It is then discounted back at the RFR for three months to get to the current time, whcih makes sense.


I dont understand why you would dicount back the $10k by the loan amount as this is a hedge and, to me, should be independent of the loan.