Forward Rate Agreement (FRA)
AdvancedAlso known as: FRA A forward rate agreement (FRA) is a contract between two parties to fix an interest rate for a set period starting at a future date, with a cash payment at the start of that period based on the difference between the agreed rate and the actual market rate. FRAs allow borrowers and lenders to lock in interest rates for future periods. No loan is actually made; only the difference in interest is paid on a notional amount. FRAs are usually described by two numbers. A 6x9 FRA covers a three-month period starting in six months and ending in nine months. For example, a company expects to borrow 10,000,000 for three months starting in six months and fears rates will rise. It buys a 6x9 FRA at 4%. If the reference rate turns out to be 4.5%, the seller pays the company the difference: 0.5% on 10,000,000 for 90 days on an actual/360 basis, about 12,500, usually discounted to the settlement date. This offsets the higher cost of its actual borrowing. FRAs are traded over the counter, mainly between banks and large companies. After the end of LIBOR, FRA activity declined and many market participants moved to alternatives such as futures and swaps based on overnight benchmark rates.
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