Forwards (Derivatives) - CFA Official Mock AM - Q 51

CFA Level II
#1

Hello Guys,

I have a question regarding Q51 of CFA Official Mock AM - Q51

[question removed by moderator]

--------------------- To be honest, I do not really understand the comments and the solution explained, for the following points:

  • An FRA has two counterparties, a fixed rate receiver that is short Euribor and a floating rate receiver that is long Euribor. When you are a floating receiver (long FRA), you pay the fixed rate (you will borrow money at rate expiration). What does that mean to be long/short Euribor? - The party that is long a 3 × 9 FRA must make a Euribor deposit in three months and earns the Euribor rate for the subsequent six months.” According to the theory when you are long FRA, you pay fixed and receive floating. You borrow money ( you do not make a deposit ). You will borrow money, you enter in a FRA in order to protect yourself from interest rate increase. Can you help and explain?
#2

Any idea guys?

#3

I cannot, but I figured out a reasoning after having looked at the answer.

Long FRA (pay FRA receive Euribor) means that you are long Euribor because you gain when Euribor increases.

And the contrary.

The deposit stuff again comes from looking at it from the Euribor and not FRA angle. You will receive Euribor for your “deposit” which in reality you do not have to make.

Would be happy if someone confirmed the above, as I said it is just my reasoning after looking at this terrible question and answer.

#4

from my understanding, you do not need to “commit” to the FRA at the expiration and no cash flow exchange is needed on inception unlike swaps.

you can just settle any “gains” or “losses” with cash.

#5

Additional question: The question is specifically in that “An FRA has two counterparties, a fixed rate receiver that is short Euribor and a floating rate receiver that is long Euribor.” - I recognised this too as wrong since FRAs should not always be on EURIBOR, should they?

#6

But in case of the vignette it is on Euribor and hence the statement is correct. You can replace Euribor for whatever floating rate you like. Just happens that in this case it is Euribor.