Since FRAs are charged on the settlement date – the start date of the fictitious loan or deposit – liquid severance pay, the interest rate differential between the market interest rate and the FRA contract rate determines the risk for each party. It is important to note that there is no major cash flow, as the amount of capital is a fictitious amount. An FRA can be used to cover future interest rate or exchange rate commitments. The buyer opposes the risk of rising interest rates, while the seller protects himself against the risk of lower interest rates. In other words, the buyer locks up the interest rate to protect himself from rising interest rates, while the seller protects against a possible drop in interest rates. A speculator may also use FRAs to bet on future changes in interest rate direction. Market participants can also use price differences between an FRA and other interest rate instruments. GPs are money market instruments that are liquid in all major currencies. As noted above, the amount of compensation is paid in advance (at the beginning of the term of the contract), while interbank rates, such as LIBOR or EURIBOR, apply to late interest transactions (at the end of the repayment period).
To account for this, it is necessary to discount the difference in interest rates using the offset rate as a discount rate. The settlement amount is therefore calculated as the present value of the interest rate difference: a futures agreement differs from a futures contract. A foreign exchange date is a binding contract on the foreign exchange market that blocks the exchange rate for the purchase or sale of a currency at a future date. A currency program is a hedging instrument that does not include advance. The other great advantage of a monetary maturity is that it can be adapted to a certain amount and delivery time, unlike standardized futures contracts. The party in a long position agrees to borrow $15 million in 90 days (settlement date). Then there will be an interest rate of 2.5% for the remaining 180 days of the contract. Company A enters into an FRA with Company B, in which Company A obtains a fixed interest rate of 5% on a capital amount of $1 million in one year. In return, Company B receives the one-year LIBOR rate set in three years on the amount of capital.
The agreement is billed in cash in a payment made at the beginning of the term period, discounted by an amount calculated using the contract rate and the duration of the contract.