CAF-7 · Chapter 10 · Question 15 of 15
Why must the final settlement amount in a Forward Rate Agreement (FRA) be discounted back to present value using the reference rate?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: C) Because the FRA cash settlement is paid at the start of the loan period, rather than at the end when normal interest would be due
Explanation
Standard loans charge interest at the END of the borrowing period. However, FRAs settle in cash at the START of the borrowing period. Because the company receives or pays the interest difference early, it must be discounted back to its present value.
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