Basic overview of a forward rate agreement by gcneophil9



A forward rate agreement (FRA) is a derivative used in the money market. It is a forward
contract, negotiated between two counterparties whose goal is the fixing of a rate in fine
reference; calculated and published by a third party, which will be known on a future date. Thus,
making it possible to secure a rate for investment on a future date.

The parallel business to the FRA futures exchanges is the money market futures. Economically,
this is essentially equivalent to the agreement of a future in the underlying investment.

The FRA agreement includes the following main components:

    - The date of commencement of a future borrowing
    - The duration of the notional borrowing (investment period)
    - The amount of the notional borrowing (the principal)
    - The agreed interest rate (FRA rate or forward rate) for future investment period
    - A reference rate for the same investment period, typically a money market rate, such as
(depending on currency), the Libor or Euribor.
    - The commencement date covered by the reference rate;

The buyer of an FRA secures the interest rate for borrowing. He protects himself against rising
interest rates, and the position of the seller is reversed.

After the expiration of the waiting period the state of the reference rate is determined. The buyer
of the FRA receives from the seller the reference rate based on the notional for the investment
period, and in return pays the agreement rate to the seller. In fact, he does not have pay both
parties, but is compensated for only the difference between the agreed FRA rate and fixed the
reference rate.

Since the buyer can refinance at the reference rate in the money market. He can back up with
the FRA on the preliminary refinancing rate. The interest expense for a given period for money
received from the FRA by the seller, so that the FRA rate persists. Analog may represent an
FRA rate on investment of funds to the seller. The eventual conclusion of an associated money
market business is mandatory for any of the parties.

The normal interest payments in arrears, would be payable at a particular point. In fact, the
compensation will be made at the end of the initial period, the amount payable is discounted
over that period. The counterparty risk of the FRA is therefore only relevant in the period until
the end of the initial period.

The value of FRAs can be similar to the value of futures, the decisive factor is the maturity, the
fixed base rates, and the related development of reference interest rates and the agreed

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