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What Are Forward Rate Agreements Used For

A company learns that it must borrow $1,000,000 in six months for a period of 6 months. The interest rate at which it can borrow today is 6 months of LIBOR plus 50 basis points. Let`s further assume that the 6-month LIBOR is currently at 0.89465%, but the company`s treasurer estimates that it could rise by 1.30% in the coming months. A FRA is an agreement between two parties who agree on a fixed interest rate to be paid/received at a fixed time in the future. The exchange of interest is based on a notional amount of capital for a period not exceeding six months. FRAs are used to help businesses manage their interest rate risks. where N {displaystyle N} is the fictitious rate of the contract, R {displaystyle R} is the fixed interest rate, r {displaystyle r} is the fixed rate -IBOR published and d {displaystyle d} is the decimalized daily counter on which the start and end data of the -IBOR rate extend. For USD and EUR, this follows an ACT/360 convention and GBP follows an ACT/365 convention. The cash amount is paid at the beginning of the value of the interest rate index (depending on the currency in which the FRA is traded, either immediately thereafter or within two working days of the published IBOR fixed interest rate). Unlike most futures contracts, the settlement date is at the beginning of the contract term and not at the end, as the reference interest rate is already known at that time, so the liability can be determined.

The requirement that payment be made as soon as possible reduces the credit risk for both parties. The duration is the date on which the contractual period ends. The FRA period is usually referred to in terms of the contract date: number of months to the settlement date × number of months to maturity. Example: 1 x 4 FRA (sometimes this notation is used: 1 v 4) means that there is 1 month between the date of the agreement and the date of settlement and 4 months between the date of the agreement and the final maturity of the FRA. Thus, this FRA has a contractual duration of 3 months. The actual description of a forward rate contract (FRA) is a derivative contract of payment against difference between two parties that is compared to an interest rate index. This index is usually an interbank interest rate (-IBOR) with a specific maturity in different currencies, e.B LIBOR in USD, GBP, EURIBOR in EUR or STIBOR in SEK. A FRA between two counterparties requires a fixed interest rate, a nominal amount, a selected interest rate index maturity and a date that must be fully specified. [1] 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 futures contract is a hedging instrument that does not involve advance payment. The other great advantage of an exchange date is that, unlike standardized exchange dates, it can be adapted to a certain amount and delivery time. .

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