Fraption

DEFINITION of 'Fraption'

A type of option that gives the option holder the opportunity to enter into a forward rate agreement at a specific strike price during a predetermined amount of time. Buyers use fraptions to protect against falls in interest rates at the cost of a slight premium.

Also known as an "interest rate guarantee".

BREAKING DOWN 'Fraption'

For example, suppose that an investor will have a deposit of $100,000 for a one-year period starting in one year. Because the investor wants a return of 10%, he or she buys a fraption for 10%. If the interest rates fall to 5% during the one-year period and the investor exercises the fraption, the fraption writer will pay out the other 5% in order to give the investor a total return of 10%