If the reference rate and the contract rate are already aligned with a contractual term, the above formula must be rewritten as follows: 2×6 – A FRA with a waiting period of 2 months (forward) and a contract duration of 4 months. The nominal amount of $5 million is not exchanged. Instead, the two companies involved in this transaction use this figure to calculate the interest rate spread. The format in which the FR is recorded is the duration until the settlement date and the duration until the due date, expressed in months and usually separated by the letter “x”. Interest rate swaps (IRSS) are often considered a set of FRAs, but this view is technically wrong due to differences in calculation methods for cash payments, resulting in very small price differentials. The day of fixation (10. October 2016), the 6-month LIBOR is set at 1.26222, which corresponds to the billing rate applicable to the company`s FRA. [US$ 3×9 – 3.25/3.50% p.a] – means that the interest on deposits is 3.25% from 3 months for 6 months and the credit rate from 3 months is 3.50% for 6 months (see also the letter margin). The seizure of an “FRA payer” means paying the fixed interest rate (3.50% per year) and obtaining a variable rate of 6 months, while the entry of a “receiver-FRA” means paying the same variable rate and obtaining a fixed rate (3.25% per year). The FRA sets the rates to be used at the same time as the date of termination and the nominal value. FRA are settled in cash on the basis of the net difference between the interest rate of the contract and the market variable rate called the reference rate.
The nominal amount is not exchanged, but a cash amount based on price differences and the nominal value of the order. Suppose the LIBOR at 6 months on the date of fixation is 3.37821%. To the extent that the reference rate is higher than the contract rate, the bank must pay a corporation the settlement amount of $6,116.29 on the execution date. Since banks are usually the counterparty to FRAs, the customer must have a line of credit established with the bank in order to enter into a forward rate agreement. A credit quality control usually requires 3 years of annual visits to be taken into account for a FRA. The duration of the contract is usually between 2 weeks and 60 months. However, FRAs are more readily available in multiples of 3 months. Competitive prices are available for fictitious capital of $5 million or more, although lower amounts may be offered by a bank for a good customer. Banks like FRAs because they don`t have capital requirements. FWD can lead to currency exchange, which would involve a transfer or settlement of money to an account.