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In order to create a synthetic FRA position of 30-day FRA on 90-day LIBOR, the diagram below shows that we can enter into positions by going long a 120-day Eurodollar contract and short a 30-day Eurodollar contract.

Here is a section from Basic of Derivative Pricing and Valuation, Reading 57, a part of CFA curriculum 2019 Level 1 Here is a section from Basic of Derivative Pricing and Valuation, Reading 57, a part of CFA curriculum 2019 Level1

Q: Looking at the diagram, is my understanding correct that what the diagram showing is 30 days from now we have to close the long position of 120-day Eurodollar at T=30 in order to achieve no exposure over 30-day period?

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You are correct. As long as you have the short and long positions on those future contracts you have a synthetic position in the 90 day FRA.

If you close both positions, it's as if you closed your position in the synthetic FRA. But if you close one leg (or it expires) and you leave the other leg open, then you will no longer have your synthetic position and you will simply have a long position in the 120-day contract.

The impotant concept here is exposure. You are synthetically creating the exposure to a 90 day FRA.

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  • $\begingroup$ Just to recap. This means that Eurodollar contract will be a cash settlement on the settlement date by paying upfront (beg of the loan) rather than at the end of the 3-month loan like in an actual loan. Am I correct? $\endgroup$
    – user506602
    Apr 23, 2020 at 10:13
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    $\begingroup$ Yes, the settlement of the futures will be upfront. Consider as a simple example that 30 days before the fixing the 90 day forward rate is 2% and you protect yourself against a rate rise with futures. If at the fixing date the rate turns out to be 3%, you will "receive" 1% from the futures and end up with a net payment of 2% (3% - 1%). The futures (1%) will be settled at the beginning and the fixing (3%) will be settled at the end. $\endgroup$ Apr 23, 2020 at 10:39

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