Forward Rate Agreement - FRA

Loading the player...

What is a 'Forward Rate Agreement - FRA'

A forward rate agreement (FRA) is 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".

BREAKING DOWN '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 variable 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. Forward Exchange Contract

    A special type of foreign currency transaction. Forward contracts ...
  2. Notional Principal Amount

    In an interest rate swap, the predetermined dollar amounts on ...
  3. LIBOR Flat

    An interest rate benchmark used to establish the floating interest ...
  4. Reference Rate

    An interest rate benchmark upon which a floating-rate security ...
  5. Funding Agreement

    A low-risk, fixed-income investment. A funding agreement offers ...
  6. Continuous Contract

    A reinsurance contract that does not have a fixed contract end ...
Related Articles
  1. Professionals

    Characteristics of Forward Rate Agreements (FRAs)

    CFA Level 1 - Characteristics of Forward Rate Agreements (FRAs). Learn the characteristics of forward rate agreements. Provides sample calculations on finding the payments upon expiration of ...
  2. Investing Basics

    Explaining Forward Rate Agreements

    Forward rate agreement (FRA) refers to an interest rate or foreign exchange hedging strategy.
  3. Professionals

    Interest Rate Options vs. FRAs

    CFA Level 1 - Interest Rate Options vs. FRAs. Learn the differences between interest rate options and forward rate agreements. Sample payoff calculations of an interest rate option.
  4. Investing Basics

    Managing Interest Rate Risk

    Interest rate risk stems from the possibility that an interest-bearing asset’s value will change due to changing interest rates.
  5. Options & Futures

    Managing Interest Rate Risk

    Learn which tools you need to manage the risk that comes with changing rates.
  6. Forex Education

    Hedging With Currency Swaps

    The wrong currency movement can crush positive portfolio returns. Find out how to hedge against it.
  7. Professionals

    Interest Rate and Equity Swaps

    CFA Level 1 - Interest Rate and Equity Swaps. Learn the components of plain vanilla interest rate swaps and equity swaps. Contains sample calculations finding the payments for each swap.
  8. Professionals

    Swap Markets and Contracts

    CFA Level 1 - Swap Markets and Contracts. Learn the basics of swaps, including how they are used and settled. Includes various methods for terminating a swap contract.
  9. Trading Strategies

    Interest Rate Swaps Explained

    Plain interest rate swaps that enable the parties involved to exchange fixed and floating cash flows.
  10. Investing Basics

    Understanding Notional Value

    This term is commonly used in the options, futures and currency markets because a very small amount of invested money can control a large position.
RELATED FAQS
  1. What does the notional principal of a derivative contract refer to?

    Find out more about the notional principal amount, interest rate swap agreements and how the notional principal amount in ... Read Answer >>
  2. What are some common markets where notional value is used?

    Find out more about the notional value of securities and which markets commonly use the notional value to indicate the total ... Read Answer >>
  3. How can an investor reduce interest rate risk?

    Learn about the different ways investors can reduce interest rate risk. Locking in interest rates increases certainty for ... Read Answer >>
  4. How can a futures trader exit a position prior to expiration?

    A futures contract is an agreement to buy or sell a commodity at a pre-determined price and quantity at a future date in ... Read Answer >>
  5. How does LIBOR compare to the Federal Reserve rate as an accurate indicator?

    Explore a comparison of the predictive efficacy of the Federal Reserve's fed funds rate and the Intercontinental Exchange's ... Read Answer >>
  6. How did the LIBOR scandal affect interest rate swaps?

    Find out how the LIBOR scandal directly enriched some interest rate swap traders and harmed others by understating the real ... Read Answer >>
Hot Definitions
  1. Law Of Demand

    A microeconomic law that states that, all other factors being equal, as the price of a good or service increases, consumer ...
  2. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  3. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  4. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  5. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  6. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
Trading Center