Interest
rate Forward Agreement Example
ABC wants to borrow an amount of 30 million for a
period of four month in two month time. Rate offered by the bank are
2 v 3
4.6-4.55
2 v 4 4.7-
4.65
2 v 6 4.8-
4.75
If Libor is 6% plus 100 bases point, then calculate
effective Interest Rate
Solution
1. Agreement
Agreement would be 2 v 6
(start in two months) and covers period of 4 months, rate would 4.8, because it
is borrowing and bank will offer high rate.
2. Comparison of LIBOR & FRA
FRA 4.8 % LIBOR is 6%
As
Libor is greater, therefore a settlement of 1.2% is to be received from the
banks. Because now it can sale FRA at LIBOR rate, which would result in profit.
3. Effective Interest
While
calculating effective interest rate, margin included, because it is part of
cost.
LIBOR + Margi 6% + 1% = 7%
Settlement received 1.2%
Effective Interest Rate (7%-
1.2%) =5.8%
