Forward Rate Agreement
A forward rate agreement (FRA) is an over-the-counter (OTC) contract between parties that determines the rate of interest to be paid on an agreed-upon date in the future. In other words, an FRA is an agreement to exchange an interest rate commitment on a notional amount.The forward rate agreement determines the rates to be used along with the termination date and notional value. FRAs are cash-settled. The payment is based on the net difference between the interest rate of the contract and the floating rate in the market—the reference rate. The notional amount is not exchanged. It is a cash amount based on the rate differentials and the notional value of the contract.
Definition:
A Forward Rate Agreement (FRA) is a financial derivative instrument used to lock in an interest rate for a specific future period. An FRA allows two parties to agree on an interest rate for a future period at the time of the agreement, to manage interest rate risk or for interest rate speculation.
Origin:
FRAs originated in the 1970s as financial markets evolved and the need for managing interest rate risk increased among corporations and financial institutions. The first FRAs appeared in the London interbank market and gradually gained widespread use globally.
Categories and Characteristics:
1. Parties Involved: Typically borrowers and lenders, banks, or other financial institutions.
2. Notional Amount: The virtual principal amount involved in the FRA, which is not actually exchanged but is used for interest calculation.
3. Agreement Period: The time period specified in the agreement, usually indicated by a
