Forward Rate Agreement - FRA

AAA

DEFINITION of 'Forward Rate Agreement - FRA'

An over-the-counter contract between parties that determines the rate of interest, or the currency exchange rate, to be paid or received on an obligation beginning at a future start date. The contract will determine the rates to be used along with the termination date and notional value. On this type of agreement, it is only the differential that is paid on the notional amount of the contract.

Also known as a "future rate agreement".

INVESTOPEDIA EXPLAINS 'Forward Rate Agreement - FRA'

Typically, for agreements dealing with interest rates, the parties to the contract will exchange a fixed rate for a variable one. The party paying the fixed rate is usually referred to as the borrower, while the party receiving the fixed rate is referred to as the lender.

For a basic example, assume Company A enters into an FRA with Company B in which Company A will receive a fixed rate of 5% for one year on a principal of $1 million in three years. In return, Company B will receive the one-year LIBOR rate, determined in three years' time, on the principal amount. The agreement will be settled in cash in three years.

If, after three years' time, the LIBOR is at 5.5%, the settlement to the agreement will require that Company A pay Company B. This is because the LIBOR is higher than the fixed rate. Mathematically, $1 million at 5% generates $50,000 of interest for Company A while $1 million at 5.5% generates $55,000 in interest for Company B. Ignoring present values, the net difference between the two amounts is $5,000, which is paid to Company B.

RELATED TERMS
  1. LIBOR

    LIBOR or ICE LIBOR (previously BBA LIBOR) is a benchmark rate ...
  2. Exchange Rate

    The price of a nation’s currency in terms of another currency. ...
  3. Forward Contract

    A customized contract between two parties to buy or sell an asset ...
  4. Variable Prepaid Forward Contracts

    An agreement to give a predetermined number of shares to a brokerage ...
  5. Fraption

    A type of option that gives the option holder the opportunity ...
  6. BAX Contract

    A BAX contract is a short-term investment instrument that uses ...
Related Articles
  1. A Primer On The Forex Market
    Options & Futures

    A Primer On The Forex Market

  2. Getting Started In Foreign Exchange ...
    Forex Education

    Getting Started In Foreign Exchange ...

  3. Getting Started In Forex
    Options & Futures

    Getting Started In Forex

  4. Options On Futures: A World Of Potential ...
    Options & Futures

    Options On Futures: A World Of Potential ...

Hot Definitions
  1. Financing Entity

    The party in a financing arrangement that provides money, property, or another asset to an intermediate entity or financed ...
  2. Hyperinflation

    Extremely rapid or out of control inflation. There is no precise numerical definition to hyperinflation. Hyperinflation is ...
  3. Gross Rate Of Return

    The total rate of return on an investment before the deduction of any fees or expenses. The gross rate of return is quoted ...
  4. Debit Spread

    Two options with different market prices that an investor trades on the same underlying security. The higher priced option ...
  5. Leading Indicator

    A measurable economic factor that changes before the economy starts to follow a particular pattern or trend. Leading indicators ...
  6. Wage-Price Spiral

    A macroeconomic theory to explain the cause-and-effect relationship between rising wages and rising prices, or inflation. ...
Trading Center