Fix your interest rates on your future loans


About FRA (Forward Rate Agreement)

An FRA is an agreement between two parties to exchange a fixed rate for a floating rate at a future date for a specific amount of money over a specific duration.

For example, a company proposes to borrow USD 10 million after three months for a tenure of six months. It agrees to pay the lender 1 percent over the six-month Libor prevailing on the date of drawdown of the loan. Since the reference rate is a floating rate, the company is not able to determine its interest cost today. To overcome this uncertainty, it could buy an FRA (3 v/s 9). In the contract, the FRA seller agrees to pay the company interest at the rate at which it would eventually be required to pay on its loan (but without the spread). In exchange, the company agrees to pay the FRA seller a fixed rate that is determined today. The company is, therefore, able to lock down its future interest cost today.

In the above example, the buyer of the FRA has borrowed effectively at a rate at which it concludes the FRA plus the spread of 1 percent, since the FRA seller will compensate or be compensated for the difference in the rate between the FRA rate and the relevant spot Libor rate determined three months hence.

Dealing and quotations

The day the transaction is initiated is called the deal date or the transactions date.

The contract period is the time between the settlement date and the maturity date.

The settlement date is two days prior to the beginning of the contract period of the liability or the asset and the date on which the settlement sum is paid.

The maturity date is when the contract ends.

The settlement sum is the money paid or received in compensation as per the terms of the FRA, on the settlement date.

The fixing date is when the reference rate of the FRA is decided. This date is usually two working dates before the settlement date. But parties can mutually decide on a date.

A quote of 9.75% - 10.25% against three-month MIBOR for 3 v/s 6 FRA means that the market maker:

Agrees to pay (bid) 9.75% fixed and receive the three-month MIBOR determined three months from today.

Agrees to receive (ask/ offer) 10.25% fixed and pay the three-month MIBOR determined three months from today.

Who can enter into FRAs?

Banks, primary dealers and financial institutions can into rupee FRAs to hedge their exposure and for market making. Corporations can enter into rupee FRAs only to hedge the interest rate risk on an underlying asset or liability

All participants may enter into non-Rupee FRAs only to hedge an underlying exposure.

An FRA protects a buyer against a rise in the interest rates on future borrowings.

An FRA protects a seller against a fall in the interest rates on loans the seller plans to advance in the future.

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