- Agreement between the bank and its client, in which they agree on a future interest rate for a loan or term deposit over a pre-agreed future period
- Intended for sole traders and companies who wish to hedge their interest rate risks
- FRA makes it possible to fix in advance an interest rate for a future borrowing or deposit, i.e. to hedge against interest rate risk
- Notional amount of the FRA is solely used as a basis for calculating FRA interest payments, notional amounts are not exchanged
- Parties do not provide a loan to each other / accept term deposits from one another – they only exchange the difference between FRA rate (agreed interest rate) and the current financial market reference rate at the start of the FRA period (interest rate period)
- FRA buyer always purchases a fixed FRA interest rate
- Reference rate is set two business days before the start of the FRA period (interest rate period) and compared with the fixed FRA rate
- FRA is settled at the beginning of the interest rate period by the party in the disadvantageous position
- Payment equals discounted difference between the fixed FRA rate and the set value of the reference rate applied to notional amount and given interest period
- There is a liquid market for FRAs with certain standard parameters (such as notional amount, reference rate and maturity)
- FRA contains the following information:
- Agreed interest rate (FRA rate)
- Interest rate period (FRA period)
- Interest rate period start, i.e. a future day, from which interest accrues on a deposit
- Notional amount, i.e. deposit amount
- Market rate that is used as the reference rate for the purpose of future performance under FRA (usually LIBOR)
- Interest rate period for FRA is determined by two terms that specify the period of time from the trade date:
- To the start of the FRA period
- To the end of the FRA period
FRA “6 to 9”: period begins 6 months from the date of conclusion of the FRA and lasts for 3 months; in other words: the interest rate for a three month deposit, which starts to bear interest in six months, is agreed today.
Level of payment when reference rate > FRA rate (FRA 3x6 concluded on 1 March)
Level of payment when reference rate < FRA rate (FRA 6x12 concluded on 1 March)
The given example is only illustrative and is intended to describe the operation and use of the product. This is not about past or expected future market developments.
