Check this out…same question (88193 and 88185), same answer choices, but different answers given. Am i missing anything here? Suppose a forward rate agreement (FRA) calls for the exchange of six-month LIBOR one year from now for a payment of a fixed rate of interest of 8%. In other words, pay floating and receive fixed. Which of the following structures is equivalent to this FRA? A long: A) call and a short put on LIBOR with a strike rate of 8% and twelve months to expiration. B) call and a short put on LIBOR with a strike rate of 8% and six months to expiration. C) put and a short call on LIBOR with a strike rate of 8% and twelve months to expiration. Your answer: A was incorrect. The correct answer was C) put and a short call on LIBOR with a strike rate of 8% and twelve months to expiration. The strike rate of the options corresponds to the fixed rate of the FRA. The expiration of the option coincides with the LIBOR determination date. Suppose a forward rate agreement (FRA) calls for the exchange of six-month London Interbank Offered Rate (LIBOR) two years from now for a payment of a fixed rate of interest of 6%. Which of the following structures is equivalent to this FRA? A long: A) put and a short call on LIBOR with a strike rate of 6% and two years to expiration. B) call and a short put on LIBOR with a strike rate of 6% and two years to expiration. C) call on LIBOR with a strike rate of 6% and eighteen months to expiration. Your answer: A was incorrect. The correct answer was B) call and a short put on LIBOR with a strike rate of 6% and two years to expiration. The strike rate of the options corresponds to the fixed rate of the FRA. The expiration of the option coincides with the determination date of the LIBOR-based payment which is paid two years from now.
that’s pretty funny. as long as the first one really means pay floating, receive fixed, then it’s fine on the answer choice. agree that if the 2nd one supposedly means the same thing, then the answer is not right. i don’t think the cfai would word something this poorly- you’ll know what you’re paying. ahh, schweser.
the phrase “payment of a fixed rate of interest of 8%” is confusing but the next sentences clarifies that this means “in other words, pay floating and receive fixed.” phrase is identical in the second question so i assume they mean the same thing. so which is the correct answer? is it long put and short call? (C in first question and A in second question).
correct- assuming they both mean pay floating, receive fixed then you’re long interest rate put/short call. you want interest rates to go down since you’re paying the floating side.
have u reviewed this topic in detail yet by the way? i spent almost the whole day on swaps and it still hasnt sunk in. i mean i can find the fixed rate, answer some short questions, maybe value an equity swap, pretty much still cant value an interest rate swap or currency swap. swaptions r easy, just like fras. im really thinking im just gona give up on the valuation of swaps because i cant envision more than like two questions where you have to do it and the opportuninty cost of trying to learn this right now especaiily given the exxpected benefit is getting to be pretty high.
Sorry whats the problem exactly? Q1: "pay floating and receive fixed Q2: “a payment of a fixed rate of interest” i.e. in Q1 you are short the FRA in (since you have to pay floating), in Q2 you are long the FRA meaning you pay fixed. The positions are exact opposites of one another so you should use the exact opposite options positions in the two questions, which is exactly what the answers give you. I hate to say it but for once Schweser seems to be right.
calls for the exchange of six-month LIBOR one year from now for a payment of a fixed rate of interest of 8% calls for the exchange of six-month London Interbank Offered Rate (LIBOR) two years from now for a payment of a fixed rate of interest of 6% ignoring the clarification in the 1st one- the 2 questions are worded exactly the same- the answers shouldn’t be different. whatever, i think we all get the idea.
both questions say "for a payment of a fixed rate of interest of " yet you are saying that one means pay floating and one means pay fixed
the show: yea I know the first one does say this, but every fra calls for that. However, the first question goes on to specify which party you are in that fra (i.e. you are the pay floating party). the second question just tells you that its for pay floating and you have to assume (since no extra info is given) that you are the pay fixed party. hope that helps.
@bannnisja: why would you ignore the clarification? it gives you more detailed pertinent info.
adavydov – both questions say exactly the same thing for the first part, but the clarification is provided only on the first question. So what told you that the second one was a pay fixed, receive floating?
cpk: The second one just says pay fixed, no clarification. Whereas the first one provides further clarification, telling you that you will be paying floating. Basically, what gave it away for me was the phrase in the first one that says “In other words, pay floating and receive fixed.” Basically, you should go about solving the second one the way you went about solving the first one since that questions doesnt provide any additional info, for the first one you should consider how the additional info reverses the situation that we are used to seeing in these questions (i.e. we are used to being the long party in these, and hence paying fixed). So, the first question says the fra is a pay fixed contract (which it always is) but it goes on to tell us that we are receiving the fixed payments rather than making them. Hope this helps.
Read the 88193 as a PAY FLOAT RECEIVE FIXED [Since they clarified what they reall want] So in that case - C is the correct ans Read the 88185 as a PAY FIXED RECEIVE FLOAT [since no clarification, I would take that as] Then in that case - B is the correct ans