Professional Documents
Culture Documents
By
Dr Amit Bagga
Forward Rate Agreement
FRA- It is a over the counter
agreement that a certain interest
rate will apply to either borrowing or
lending a certain principal during a
specified future period of time.
Consider a FRA where bank xx is
agreeing to lend money to company
zz for the period of time T1 and time
T2… Defined:
Rk –The rate of agreement to in the FRA
Rm -The actual Libor/ Mibor interest rate
observed in the market at time T1 for
the period between time T1 and T2
L- Principal amount
A (0.1150 – 0.10875)X
1 + 0.1150(91/365)
=
5000000X(91/365)
=7573.94
Notice that the upfront payment by the FRA seller equals the
difference in interest on £ 5 million for 91 days at the actual
libor and the contracted rate, discounted at the actual libor.
Case 2
(0.08125 –
A
0.0750)(5000000)(92/360)
= (1+
=
0.0750(92/360)
7835.9
Hedging of FRA risk with
Interest rate Future
For Borrower:
A borrower will always short interest rate
future in order to hedge the risk of
increase in interest rate with the
amount equivalent to the principal
amount .
For Investor/lender:
An investor will always long interest rate
future in order to hedge the risk of fall
in interest rate with the amount
Valuation of FRA
At time T0
Consider an FRA where we will receive a rate of 6%
on a principal of Rs 100 Million between the end
of year 1 and the end of year 2. The forward rate
is 5.127%
At time T1
A company enters into an FRA, receives a
fixed rate of 4% on a principal of Rs 100
Million for a 3 month period starting in
3years. If 3 month libor proves to 4.5% for
the 3 month period.