# FRA

Can someone kindly explain a) which LIBOR rate to use, and b) how they arrive at a final answer? I’ve summarized the question below.

John enters into a 1x3 FRA with 1.5% LIBOR and \$1MM notional principal. At expiration, the 60D LIBOR is 1.7% and the 90D LIBOR is 1.6%. What payment will John most likely receive?

Take a look at the article I wrote on FRAs; it may be of some help: http://financialexamhelp123.com/fras/

You’ll use the 60-day rate: a 1×3 FRA means that the FRA expires in one month and the loan period expires in three months; thus, the loan period is 60 days.

Thank you. Just a question on the example in your article, why isn’t the discount rate in the denominator 3.6% raised to (9/12)? I’m asking because I thought that discounting back usually involved dividing by (rate^number of periods). Thanks again.

It looks like 3.6% is the annual rate so 9months/12months gives you the rate applicapble to the 9 month loan.

Because LIBOR is a nominal rate, not an effective rate.

I wrote an article on nominal vs. effective rates (http://financialexamhelp123.com/nominal-vs-effective-interest-rates/) and another on FRAs (http://financialexamhelp123.com/fras/); perhaps they’ll be of some small help.

But that’s true only because it’s a nominal rate. If it were an effective rate you’d have to use 1.036^(9/12) – 1 = 2.6880%.