4. Forward Rate Agreements
e. define a forward rate agreement and describe its uses;
What is a forward rate agreement?
A forward rate agreement (FRA) is a forward contract in which one party, the long, agrees to pay a fixed interest payment at a future date and receive an interest payment at a rate to be determined at expiration. It is a forward contract on an interest rate (not on a bond or a loan).
In a forward rate agreement (FRA) what is another name for the fixed rate?
The fixed rate is also called the forward contract rate.
In a forward rate agreement (FRA) what is another name for the interest rate?
The interest rate is also called the underlying rate.
How do the buyer and seller of forward rate agreements (FRA) profit?
- The buyer of a FRA profits from an increase in interest rates.
- The seller of a FRA profits from a decline in rates.