# An agreement on the future interest rate (fra)

What is the Forward rate agreement (fra)’

Of forward rate agreements (fra) is an OTC contract between parties that determines the interest rate or the exchange rate that must be paid or received on the obligation beginning on a future date. Fra determines the rates will be used along with the expiry date and nominal value. FRAS cash payment based on the net difference between the interest rate and the base rate in the contract. The notional amount is not changed.

The breaking down of the contract ‘forward rate (fra)’

Forward rate agreements on interest rates in respect of interest rates, tend to see both parties exchange fixed interest rate for a variable one. Of the party paying the fixed rate, called the borrower, and the party receiving the variable rate, called the creditor.

As a basic example, suppose that company a contracts with company B FRA, in which the company will receive a fixed rate of 5% for one year on the principal amount of \$ 1 million in one year. In return, company B will get one-year LIBOR rate, which is determined every three years, on the principal amount. The agreement will be settled in cash the payment made at the beginning of the forward period, discounted by an amount calculated as the value of the contract and the term of the contract.

Forward Agreement Formula Rates

The formula for the payment of the fra takes into account five different variables. They are:

FR = velocity of fra

R = base rate

NP = notional principal

P = period, the number of days in the contract period

Y = the number of days in a year, based on the correct day-count Convention on the contract for

FRA payment amount is calculated by multiplying two terms, the settlement amount and the discount factor:

Payment of fra = (((R – FR) x NP x G) / G) x (1 / (1 + R X (R)))

Assume the following data:

FR = 3.5%

R = 4%

NP = \$5 million

P = 181 days

G = 360 days

Payment quantity is calculated as:

Payment by fra= (((4% – 3.5%) 5,000,000 x \$x 181) / 360) x (1 / (1 + 4% x (181 / 360))) = \$12,569.44 x 0.980285 = \$12,321.64

If the payment amount is positive, the fra seller pays this amount to the buyer. Otherwise, the buyer pays the seller. And during the day-count Convention, if the contract is in sterling, 365 days. In all the other currencies of the Convention is to use 360 days.

A nominal amount of \$ 5 million is not exchanged. And two companies involved in this deal, using this figure to calculate the interest rate.