Forward Rate Agreements

The cash amount is paid at the beginning of the value applicable to the interest rate index (depending on the currency in which the FRA is traded, either immediately after or within two working days of the published IBOR fixed rate). There are no fees or other direct costs related to FRA. The price of a FRA is simply the fixed rate at which the FRA has been agreed between you and the bank. The fra interest rate depends on the duration of the FRA, the objective of the agreement and the current market rates. The nominal amount of $5 million is not exchanged. Instead, the two companies involved in this transaction use this figure to calculate the interest rate spread. A term statement may be made either in cash or on a delivery basis, provided that the option is acceptable to both parties and has been previously defined in the contract. Variable rate borrowers would use FRA to change their interest costs by changing interest rates in a market where variable interest rates are expected to rise, from a variable rate to a fixed rate. Fixed-rate borrowers could use a FRA to switch from fixed-rate to variable-rate payments in a market where variable interest rates are expected to fall.

For example, XYZ Corporation, which borrowed on the basis of variable interest rates, estimated that interest rates would likely rise. XYZ chooses to pay all or part of the remaining term of the loan fixed by means of a FRA (or a series of FRAs (see interest rate swaps), while its underlying loan remains variable but is guaranteed. . . .

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