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Hedging interest rate risk

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.

 Terminology – '5v8 FRA', '5-8 FRA'.

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

Illustrations and further practice

Now try Illustration 1 in Chapter 11

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