Forward Rate Agreement

( FRA)
 Learning Objectives
• The students will be able to learn and
understand:
1. The meaning of forward rate agreement
2. Characteristics of FRA
3. Features of FRA
 Current News
• The government has put off implementation of the uniform stamp
duty on transfer of shares, debentures, futures, options, currency
and other capital market instruments to July 1, 2020.
The finance ministry also clarified that there is no change in the
financial year.
"There is no extension of the Financial Year," said a finance ministry
statement, clarifying that the notification issued by the department
of revenue pertained to amendments in the Indian Stamp Act.
Read more at:
https://economictimes.indiatimes.com/news/economy/policy/govt
-extends-implementation-of-the-uniform-stamp-duty-for-capital-
market-instruments-to-july-
1/articleshow/74900870.cms?utm_source=contentofinterest&utm
_medium=text&utm_campaign=cppst
 Forward Rate Agreement
• Due to volatility in the interest rates, financial
community has created various instruments in
order to control and manage the
consequences.
• One of the instrument to hedge against
interest rate risk is FRA
 FRA - Definition
• It is a financial contract between two parties
to exchange interest payment for a “Notional
Principal” amount for a specified period from
start date to maturity date.
• Example- A firm plans today (say 1.7.2019) to
borrow US $ 5 million, 3 months hence (i.e.
1.10.2019) for a period of 6 months (
1.10.2019 to 31.3.2020)
 FRA- Definition
• Example-
• Being apprehensive of future interest rate
increase, may like to lock in the effective
interest costs to day itself by buying a3/9 FRA.
• This means that ‘from three months from
today, for borrowing for a period of 6 months’
• On the settlement date cash payments based
on contract rate and settlement rate are being
made by the parties to one another.
 Characteristics of FRA
• It involves quoting interest rate from a certain
future date to a further future date.
• Although the agreement is always with
reference to a certain future principal sum,
the principal amount is never exchanged.
• On the relevant date actual LIBOR is compared
with the FRA rate and only the difference
between two rates is received or paid as the
case may be, on the principal amount agreed.
 Mechanism of FRA
• An agreement may be stuck between two
banks or a bank and its corporate clients.
• A agreement covering a three months period
that begins six months from the date of
contract is called “six against nine”
• One that covers six month period beginning
six months from the date of contract is called
a “six against twelve”
 FRA’s Hedging technique
• They can also b e bought to lock in the
effective interest cost where new debt
securities are to be issued at a later date to
reduce interest rate exposure if higher interest
rates are forecasted.
 Features of FRA
• Traded in the OTC market
• No standardization of amount
• Never any transaction of principal
• Interests applied are LIBOR
• Contracted currency, amount, contract rate,
settlement date are specified in advance.
• No obligation to borrow or lend
• Lock in rate
• Low credit risk
• Cancellation and assignment ( irrevocable)
 Advantages
• Hedging instrument
• Low credit risk
• Flexibility- you can reverse the position by
making offsetting contracts
• Balance sheet- treated as off balance sheet
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