Page 170 - Microsoft Word - 00 CIMA F1 Prelims STUDENT 2018.docx

Chapter 13

Forward rate agreements (FRAs)

2.1 Definition

 An FRA is a forward contract on an interest rate for a notional future
short-term loan or deposit.

2.2 Features and operation

 The FRA does not replace taking out the loan (deposit) but rather the
combination of the loan (deposit) and the FRA result in a fixed effective
interest rate.

 If looking to borrow money then you need to buy an FRA.

 If looking to deposit money then you need to sell an FRA.

 A receipt or payment will be made at the start of the loan period that will
compensate for interest rate changes between the FRA and the market rate for
the loan.

 FRAs are normally for amounts greater than £1m.

 Terminology – '5v8 FRA', '5-8 FRA'.

 Quoted rates – use higher rate if borrowing, lower rate if depositing.

160