Derivative Investments:Forward rate agreements

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Questions 1:

Forward rate agreements are most likely used to hedge an exposure in the:

A. foreign exchange market.

B. money market.

C. equity market.

Questions 2:

A corporation issues five-year fixed-rate bonds. Its treasurer expects interest rates to decline for all maturities for at least the next year. She enters into a one-year agreement with a bank to receive quarterly fixed-rate payments and to make payments based on floating rates benchmarked on three-month LIBOR. This agreement is best described as a:

A. futures contract.

B. swap.

C. forward contract.

View answer resolution

【Answer to question 1】（B）

【analysis】

Forward rate agreements are used to hedge interest rate exposure present in the money market

【Answer to question 2】（B）

【analysis】

A swap is a series of forward payments. Specifically, a swap is an agreement between two parties to exchange a series of future cash flows. The corporation receives fixed interest rate payments and makes variable interest rate payments. Given that the contract is for one year and the floating rate is based on three-month LIBOR, at least four payments will be made during the year.

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