USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
TexMex Corporation has decided to borrow $50,000,000 for six months in two three-month issues. The corporation is concerned that interest rates will rise over the next three months. Thus, the corporation purchases a 3 * 6 FRA whereby the corporation pays the dealer's quoted fixed rate of 3.5 percent in exchange for receiving three-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from Newport Inc. at its bid rate of 3 percent. The notional principal is $50,000,000 and that there are 60 days between month 3 and month 6.
-Refer to Exhibit 15.18. How much compensation does the dealer receive for transaction costs, credit risk, and other costs associated with matching the FRAs?
A) $42,700
B) $62,500
C) $82,000
D) $96,300
E) $0

Question

Quizplus · Accepted Answer

The dealer receives compensation based on the difference between the fixed rate paid by TexMex (3.5%) and the bid rate from Newport Inc. (3%). The compensation is calculated as: (0.5% / 100) * $50,000,000 * (60/360) = $62,500.