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Forward rate agreements (FRAs)


  • In general:
  • A forward rate agreement (FRA) is an over the counter agreement where the forward interest rate,
  • Ft1,t2 ,is fixed for a certain principal between times T1 and T2
  • The payer of the fixed interest rate is also known as the borrower or the buyer. The buyer hedges against the risk of rising interest rates, while the seller hedges against the risk of falling interest rates
  • Payment to the long at settlement = Notional Principal X (Rate at settlement – FRA Rate) (days/360)                                                                                                                        ----------------------------------------
                                                                                                  1 + (Rate at settlement) (days / 360)


An FRA settles in 30 days
Has $1mn notional
Is Based on 90-day LIBOR
Forward rate of 5%, Actual 90-day LIBOR at settlement is 6%
What is the value of FRA at settlement


Value at the end of agreement = (6% – 5%) * (90/360)* $1mn = $2,500
Value at settlement: 2,500 / (1 + (90/360)*6%) = $2,463


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