In the financial field, an interest rate agreement in advance (FRA) is an interest rate derivative (IRD). These include a linear IRD with strong associations with interest rate swaps (IRSs). Since banks are usually the counterparty to FRAs, the customer must have a line of credit established with the bank in order to enter into a forward rate agreement. A credit quality control usually requires 3 years of annual visits to be taken into account for a FRA. The duration of the contract is usually between 2 weeks and 60 months. However, FRAs are more readily available in multiples of 3 months. Competitive prices are available for fictitious capital of $5 million or more, although lower amounts may be offered by a bank for a good customer. Banks like FRAs because they don`t have capital requirements. The FRA sets the rates to be used at the same time as the date of termination and the nominal value. FRA are settled in cash on the basis of the net difference between the interest rate of the contract and the market variable rate called the reference rate. The nominal amount is not exchanged, but a cash amount based on price differences and the nominal value of the order. Evaluate a swap as a series of futures contracts, the formula being as follows: a term statement can 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.
A company learns that it must borrow $1,000,000 in six months for a period of 6 months. The rate at which it can borrow today is 6 months LIBOR plus 50 basis points. Let`s also assume that the 6-month LIBOR currently stands at 0.89465%, but the company treasurer thinks it could rise up to 1.30% in the coming months. The parties are classified as buyers and sellers. Conventionally, the buyer of the contract who wants a fixed interest rate receives a payment when the reference rate is higher than the FRA rate; If lower, the seller receives payment from the buyer. Buyers and sellers are sometimes referred to as borrowers and lenders, although fictitious capital is never loaned. Future Interest Rate Agreements (FRA) are over-the-counter contracts between parties that set the interest rate to be paid on an agreed date in the future. A FRA is an agreement to exchange an interest rate bond on a nominal amount. Remember that the interest rate for the fixed leg line was set when the contract was signed and is set until the deadline.
In concrete terms, the buyer of the FRA, which limits a fixed interest rate, is protected from an increase in interest rates and the seller benefiting from a fixed credit rate is protected against a fall in interest rates. If interest rates don`t go down or up, no one will benefit. We learn different conceptions of interest rates and some of the contracts that are related to them. Interest is the rent paid for a loan. A loan is the securitized form of a loan. There are coupon bonds and zero coupon bonds. The latter are also called discount bonds. Interest rates and bond prices depend on their maturity. The maturity structure is the function that the maturity period gives to the corresponding interest rate or borrowing price. An important reference rate for many interest rate contracts is libOR (London Interbank Offered Rate). Loans can be borrowed over future time intervals at interest rates agreed today.
These courses are called futures or futures courses depending on the type of agreement. In the case of an interest rate swap, counterparties exchange a flow of fixed-rate payments for a flow of variable-rate payments, usually indexed to LIBOR. Duration and convexity are the basic instruments for managing the interest rate risk inherent in a bond portfolio. We also check some of the most common market conventions that come with data on the interest rate market….