We think of a company that has to invest capital in six months (t1) over six months (t2) and we fear that the level of interest rates will fall in the coming months. Therefore, the company decides to close a FRA 6×12, that is, to pay, in six months, the interest rate currently in force on the market against the price of the FRA (forward rate). Assuming that on date t1, the market exchange rate is 4% and the rate before 5%:Return on investment: liquidation of the FRA: interest rate recovered: interest rate paid: Balance: Final result: Note that the FRA is not settled at maturity, but on the start date of the investment (which corresponds to the date from which interest begins). the equivalent of the contract is by:. The Forward Rate Agreement (FRA) is a derivative contract in which the parties agree to exchange, at the expiry of the contract, the difference between a fixed interest rate (or forward rate) and a market variable rate (or settlement rate) multiplied by the duration of the contract and the nominal capital. The period between the date of conclusion of the contract and the date from which interest begins is called the “Grace period”, which allows you to be immune to any future changes in interest rates. The seller fra receives the payment on the basis of the fixed rate and makes the payment on the basis of the variable rate, while the buyer collects the payment on the basis of the variable rate and makes the payment on the basis of the fixed rate. Since both contracting parties are required to provide their service, the FRA is a symmetric derivative contract. Fra makes it possible to immunize against future changes in interest rates; Fra allows you to invest or take on debt at a later date at the current utilization rate. The sale of the FRA allows a person who needs to make a future investment to block the current attacking game. If, at the time of the investment, the market exchange rate is lower than the FRA rate, the contractual seller receives this difference, while the opposite happens when the opposite situation occurs. In any case, the FRA investor/seller will receive a return equal to the initial interest rate of his future investment.
This is the reason why the seller of a FRA is usually a subject who expects (or fears) a future interest rate cut; conversely, the buyer of a FRA is the one who expects (or fears) an increase in interest rates. FRA, like all derivatives, can be used for hedging, speculation and arbitrage purposes. Fra is a non-standard derivative contract traded on over-the-counter markets through bilateral trades. is not traded on regulated markets. 4 FLAVIO ANGELINI (2) Euro-Placement until the maturity date s. Let`s see what money is produced on the end date of the two investments. It is obvious that, in order to avoid arbitrage, these amounts must be the same, given that the same amount has been invested in t 0 and that, in both cases, there is no revenue or cost; If they were not equal, you could invest in the transaction that will pay the highest amount by financing yourself entirely with the other transaction (i.e. by selling empty) to obtain a due arbitrage, i.e. a net zero in t 0 and T and a positive sum in s. . .