Forward Rate Agreement Explication


A borrower could enter into a rate agreement in advance for the purpose of guaranteeing an interest rate if the borrower believes that interest rates may increase in the future. In other words, a borrower might want to set their cost of borrowing today by entering into a FRA. The cash difference between the FRA and the reference rate or variable rate shall be paid on the date of the value or on the date of invoice. The buyer of an interest rate agreement in advance concludes the contract in order to guard against any future increase in interest rates. The seller, on the other hand, concludes the contract to protect himself against a future fall in interest rates. For example, a German bank and a French bank could enter into a semi-annual forward rate contract, under which the German bank will pay a fixed rate of 4.2% and receive the variable interest rate on the capital of 700 million euros. An appointment is different from a futures contract. An exchange date is a binding contract in the foreign exchange market that sets the exchange rate for buying or selling a currency on a future date. A currency attacker is a hedging instrument that does not include an advance. The other great advantage of an exchange date is that, unlike standardized exchange dates, it can be adapted to a certain amount and a given delivery time. FRA contracts are over-the-counter (OTC), which means that the contract can be structured in such a way as to meet the specific needs of the user.

FRA are often based on the LIBOR rate and represent forward interest, not spot prices. Remember that spot prices are necessary to determine the futures price, but the spot price is not equal to the futures price. The current value of a differentiated FRA, exchanged between the two parties and calculated from the point of view of the sale of a FRA (imitating the receipt of the fixed rate) is as follows:[1] It is seen that the operator who seeks to hedge against a rise in rates (term borrowing position) is a buyer of a FRA. Conversely, the one who seeks to hedge against a rate cut (lending position) to be a seller. [US$ 3×9 – 3.25/3.50% p.a] – means that the interest on deposits is 3.25% from 3 months for 6 months and the credit rate from 3 months is 3.50% for 6 months (see also the letter margin). Entering an “FRA payer” means paying the fixed interest rate (3.50% per year) and getting a 6-month variable rate, while entering a “receiver-FRA” means paying the same variable rate and getting a fixed rate (3.25% per year).

Pin It