Forward Rate Agreement Price
on mars 31st, 2023 at %H:%MA forward rate agreement (FRA) is an over-the-counter (OTC) contract between two parties to lock in an interest rate on a future loan or investment. The forward rate agreement price refers to the agreed upon rate set at the time of the contract`s creation.
FRAs are used to hedge against the risk of interest rate fluctuations. For example, if a party expects to take out a loan in six months` time but is concerned that interest rates may rise, they may enter into an FRA to lock in a rate now. By doing so, they can guarantee the cost of borrowing and avoid the uncertainty of fluctuating rates.
The FRA price is determined by the difference between the prevailing market rate and the agreed-upon forward rate. The prevailing market rate is the current rate for a given loan or investment, while the forward rate is the rate set in the FRA contract.
For example, suppose the prevailing market rate for a six-month loan is 5%, but a borrower is concerned that rates may rise before they take out the loan. They could enter into an FRA at a forward rate of 6%. In this case, the FRA price would be the difference between the two rates, which is 1%.
If interest rates do rise, the borrower is protected by the FRA contract and can borrow at the agreed-upon forward rate of 6%. If rates fall, the borrower may choose not to exercise the FRA and instead borrow at the prevailing market rate of 5%.
While FRAs can provide protection against interest rate fluctuations, they do come with risks. For example, if interest rates do not move as expected, one party could be stuck paying a higher rate than they would have otherwise. Additionally, FRAs are not standardized contracts, so there is no centralized market for trading or settling them.
In conclusion, the forward rate agreement price refers to the agreed-upon rate set in an FRA contract. FRAs can be a useful tool for hedging against interest rate risk, but they do come with risks and are not standardized. Understanding the FRA price and how it is determined is an essential aspect of using this financial instrument effectively.