4. A person who has committed to lend money at a future date purchases a forward rate agreement to protect against interest rate risks, and a person who has committed to lend money at a future date sells an interest rate agreement to cover his or her interest rate risk. Each FRA has a specific nominal value called fictitious capital. The implication is that this amount is only indicated to facilitate the calculation of the payment from one counterparty to another, and that no party company is obliged to borrow / borrow this amount. The market interest rate at which the contract interest rate is compared is called the reference rate, which is usually the London Interbank Offered Rate (LIBOR). On the other hand, when the reference rate is stable at 6.25% on the settlement date, for example, the company pays the seller of FRA the difference of 0.25% (6.5-6.25) on the fictitious capital of Ls. 1 crore, which is remunerated at 6.25%. Therefore, in both cases (whether the interest rate goes up or down), the company`s effective rate remains unchanged at 6.5%. The interest rate of a forward rate agreement is called the contract rate. The party who agrees to pay this rate is referred to as the buyer of the FRA or long, while the counterparty is known as the seller of the FRA or the Short. If the real interest rate after A month is higher than the contractual rate, the long receives a payment from the shorts.
And if the rate was lower, the long would have to pay for the shorts. The nominal amount of $5 million is not exchanged. Instead, the two companies involved in this transaction use this figure to calculate the interest rate spread. Take advantage of our know-how and wide range of products, including interest rate swaps, caps, floors, short- and long-term foreign exchange options, cross-swaps, integrated with options and swaps. FRAs can be used effectively to maintain interest rates and thus bridge the gaps between interest rate-sensitive assets and liabilities on the balance sheet. That is why they are very useful in asset management. 2. Short-term interest rate agreements shall be over-the-counter derivatives used to hedge short-term interest rate risk. In the same way, if we lend money for 3m at 7.30% and we renew this loan for 9m at the end of three months (the interest rate of such a loan at the front must be calculated) and we lend the money at 8.50% at the same time for 12m, the following equation will be true.
A FRA is a simple interest rate futures contract for which performance is limited to the interest rate spread of a certain nominal capital. So it`s easy to understand its mechanism, implications, and billing calculations. . . .