What is a Forward Rate Agreement?

Forward interest rate agreements are a way of preserving the risk of interest rate changes in international financial markets. The forward rate agreement preservation was generated in the London financial market and was quickly accepted by major financial centers in the world. With the widespread application of forward rate agreements, a "forward rate agreement" market was formed in London in June 1984. The value of the forward interest rate agreement is that after the establishment of the loan relationship, the borrower and the lender will sign a "forward interest rate agreement", agreeing the date of interest calculation, and on the date of interest calculation, the interest rate agreed at the time of signing the contract with the London Interbank Fund LI-BOR comparison. If the agreement stipulates that the interest rate is lower than the LI-BOR interest rate, the difference incurred shall be paid by the lender to the borrower. If the agreement stipulates that the interest rate is higher than the LIBOR interest rate, the borrower will pay the excess to the lender. The use of forward interest rate agreements to maintain value can not only avoid the tedious forward foreign exchange application of both borrowers and lenders, but also achieve the purpose of avoiding the risk of interest rate changes. And this business itself is not a lending behavior and does not appear on the bank's balance sheet, so it is not subject to government regulations. ^[1]

Forward rate agreement

Right!

Forward interest rate agreements are a way of preserving the risk of interest rate changes in international financial markets. The forward rate agreement preservation was generated in the London financial market and was quickly accepted by major financial centers in the world. With the widespread application of forward rate agreements, a "forward rate agreement" market was formed in London in June 1984. The value of the forward interest rate agreement is that after the establishment of the loan relationship, the borrower and the lender will sign a "forward interest rate agreement", agreeing the date of interest calculation, and on the date of interest calculation, the interest rate agreed at the time of signing the contract with the London Interbank Fund LI-BOR comparison. If the agreement stipulates that the interest rate is lower than the LI-BOR interest rate, the difference incurred shall be paid by the lender to the borrower. If the agreement stipulates that the interest rate is higher than the LIBOR interest rate, the borrower will pay the excess to the lender. The use of forward interest rate agreements to maintain value can not only avoid the tedious forward foreign exchange application of both borrowers and lenders, but also achieve the purpose of avoiding the risk of interest rate changes. And this business itself is not a lending behavior and does not appear on the bank's balance sheet, so it is not subject to government regulations. ^[1]

Avoids the risk of interest rate changes by fixing the actual interest rate to be delivered in the future

Interest rate

Amount agreed-borrowed

The price of FRA refers to the agreed interest rate for a certain period from the date of interest calculation, the FRA's quotation method and

in

Consider the two forward interest rate agreements at time t. Their nominal principals are both A and the agreed future maturity are both T * T. The first FRA's agreed interest rate uses the market forward rate rF, and the second FRA's The agreed interest rate is rK. Obviously, the only difference between these two FRAs is the interest payment at time T *. In other words, the value difference between the second FRA and the first FRA at time t is the present value of different interest payments at time T ^ *

Since the agreed interest rate in the first FRA is the theoretical forward rate, its forward value should be zero. Then the value of the second FRA is equal to equation (1).

Equation (1) is suitable for the calculation of the value of any forward rate agreement with an agreed interest rate.