Foward Rate Lecture - Debt Instruments and Markets...

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Debt Instruments and Markets Professor Carpenter Forward Rate Agreements 1 Forward Rate Agreement (FRA) Forward Contract Valuation FRAs and Swaps Veronesi, pp.162-167
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Debt Instruments and Markets Professor Carpenter Forward Rate Agreements 2 A forward rate agreement (FRA) is a contract between two counterparties to exchange a fixed interest payment for a floating interest payment on a single date. Large, liquid, over-the counter market. $47 trillion notional amount outstanding in 2009. Most contracts are linked to LIBOR or Eurobor. Contracts can be customized. To take a simple example, consider a contract on a 0.5-year rate. The fixed receiver pays interest at some maturity date t at the floating rate t -0.5 r t in exchange for interest at fixed rate f , on an agreed notional amount N. There would be a single cash flow at time t . The fixed payer would pay the fixed receiver N x ( f - t -0.5 r t )/2 Actually, in practice, the payoff is settled when it becomes known at time t -0.5 at [ N x ( f - t -0.5 r t )/2]/(1+ t -0.5 r t /2) but this does not change the value.
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