6119 - 16.35 - FRAs - FINAL-1 - Forward Rate Agreement Finance Assignment Forward Rate Agreement Master Business Administration 4AE6\/4B Academic Year

6119 - 16.35 - FRAs - FINAL-1 - Forward Rate Agreement...

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Forward Rate Agreement Finance Assignment Forward Rate Agreement Master Business Administration 4AE6/4B Academic Year: 2009 – 2010 Antonia Nikolova – student number: 214175 Elena Tocu – student number: 214517 Jagna Magdalena Golebiewska – student number: 186851 Katarzyna Jurowczyk – student number: 214299 1
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Forward Rate Agreement Table of contents: 1. Introduction ................................................................................................................... 3 2. Definition of Forward Rate Agreement ........................................................................ 3 3. Characteristics of Forward Rate Agreement ................................................................. 4 4. Terminology ................................................................................................................... 5 5. Timing for Forward Rate Agreement ............................................................................ 5 6. Features of Forward Rate Agreement ........................................................................... 6 7. The settlement process ................................................................................................... 7 8. FRA use in practice ........................................................................................................ 8 9. Hedging with FRAs ....................................................................................................... 9 10. Pricing of Forward Rate Agreement ............................................................................ 11 10.1. The method of ‘filling the gap’ ........................................................................ 11 10.2. The FRA formula ............................................................................................. 12 10.3. Excel example .................................................................................................. 14 11. References .................................................................................................................... 15 2
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Forward Rate Agreement (FRA) - is an agreement between two parties motivated by the wish either to hedge against or to speculate on movement in future interest rates. Forward Rate Agreement 1. Introduction Since 1980s, intensive globalization of financial markets, two trends could have been observed. Primarily, we could talk about the process of securitization which had a big influence on minimizing distinction between bank credits and capital markets. Secondly, increasing importance of off-balance-sheet items, especially derivative products such as interest rate swaps, interest rate options and forward rate agreement. These are examples of financial engineering tools which can offer the comfort of certainty to anyone exposed to financial risk. (Ref: ‘On the origins of the BIS macro-prudential approach to financial stability…’) 2. Definition of Forward Rate Agreement The forward rate agreement is a contract between two counterparties to fix a future interest rate. This contract defines the interest rate for a future period based on a principal. (Ref: ) The FRA is an agreement to borrow or lend a notional cash sum for a short period of time (lasting normally up to twelve months), starting at any point over the next twelve months, at an agreed rate of interest (the FRA rate). The “buyer” of an FRA is borrowing a notional sum of money while the “seller” is lending this cash sum. In the FRA market, to “buy” is to “borrow”. We use the term “notional” because with an FRA no borrowing or lending of cash actually takes place, as it is an off-balance sheet product. (Ref: ) 3
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Forward Rate Agreement 3. Characteristics of Forward Rate Agreement 1. FRAs are an over the counter (OTC) products offered by banks which mean trading directly between two parties from their dealing rooms, linked together by telephone, information feeds, and computer networks. (Ref: Financial Engineering) 2. FRAs do not involve any transfer of principal. They are settled at maturity in cash, representing the profit or loss resulting from the difference in the agreed rate (FRA rate) and the settlement rate at maturity. (Ref: ciberconta.unizar.es) 3. The two parties bear a risk of not fulfilling the contract conditions - counterparty risk. (Ref: Financial Engineering) 4. Elastic form and low level of provisions. It is required for banks to allocate some capital to
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  • Fall '10
  • Bart Vinck
  • Interest Rate, ........., Money market, FRAS

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