Menu Close

Future Rate Agreement Example

[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). The seizure of an “FRA payer” means paying the fixed interest rate (3.50% per year) and obtaining a variable rate of 6 months, while the entry of a “receiver-FRA” means paying the same variable rate and obtaining a fixed rate (3.25% per year). Let`s understand the concept of FRA with the help of a few examples: there are two parties that participate in a purchase rate agreement, namely the buyer and the seller. The buyer of such a contract sets the interest rate on the start date of the contract and the seller sets the interest rate on the credit. When creating a FRA, both parties have no profit/loss. Since FRA are paid in cash on the start date of the fictitious loan or deposit, the interest rate difference between the market rate and the FRA contract rate determines the commitment to each party. It is important to note that since the amount of capital is a nominal amount, there is no main cash flow. FRAs are not loans and do not constitute agreements to lend any amount of money to another party, on an unsecured basis, at a known interest rate. Their nature as an IRD product only produces leverage and the ability to speculate or hedge interest rate risks. Define a forward interest rate agreement and describe its use The cash exchanged between the two parties for the differential value of a FRA calculated from the point of view of the sale of a FRA (imitating the receipt of the fixed rate) is calculated as follows:[1] As mentioned above, the invoice amount is paid in advance (at the beginning of the contract term). while interbank rates such as LIBOR or EURIBOR apply to late payment interest transactions (at the end of the loan period). To take this into account, the interest rate spread must be discounted, with the settlement rate being used as the discount rate.

The amount of the comparison is therefore calculated as the present value of the interest rate spread: Company A enters into a FRA with Company B in which Company A obtains a fixed interest rate of 5% on a nominal amount of $1 million in one year.