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FRA Payoff formula

June 11, 2012

If rate increases long party/end user receives payment:

  1. Underlying Rate at Expiration – Forward Contract Rate
  2. Notational Principal * Rate Difference * Days in Underlying Rate / 360
  3. Discount payment back using Underlying Rate at Expiration raised to (Days in Underlying Rate / 360)

This is one of the biggest, nastiest formula in CFA Level 1, so it helps to break it down.

  • FRA Payoff Numerator = NP * (Underlying Rate at Expiration – Forward Contract Rate) * (Days in Rate / 360)
  • FRA Payoff Denominator = 1 + [Underlying Rate at Expiration^(Days in Underlying Rate / 360)]

Maintaining at least four decimal points of accuracy is important if you have to calculate forward rate agreement payoff in an exam.

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6 Comments
  1. Hi, I think your formula of FRA Payoff Denominator is not correct. It should be FRA Payoff Denominator = 1 + Underlying Rate at Expiration^(Days in Underlying Rate / 360)

    • That’s interesting. I assure you’ve I’ve done 100s of practice problems and that is the formula I’ve used. Perhaps a real math person can say they are equivalent but I don’t think they are, my formula should yield a bigger denominator. I have to say with the original flash card In my hand I’m write, but I decided to consult Schweser’s Quicksheet as it is in my desk too, the don’t seem to do things this way, this card comes from needing to solve specific questions which appear in level 1 and 2 that I encountered, I know this card well or thought I did. I consulted the book they are not teaching this so much in Level 2, my Level 1 books are back in Canada. I shall have to research this further, thanks for commenting.

    • I’ve seen several forum posts which aren’t always reliable but they seem to agree with you, because you choose the closest answer maybe I got lucky all these years, but I must change two spreadsheets too, but it seems this card may be wrong, hence why I put a disclaimer I guess.

Trackbacks & Pingbacks

  1. 29 CFA Questions you should be able to answer – Muskblog
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