For example, if the Federal Reserve Bank is raising U.S. interest rates, the so-called monetary tightening cycle, companies would likely want to raise their borrowing costs before interest rates rise too dramatically. In addition, FRA are very flexible and settlement dates can be tailored to the needs of transaction participants. Since FRA are paid in cash on the start date of the fictitious loan or deposit, the interest rate difference between the market rate and the FRA contract rate determines the commitment to each party. It is important to note that since the amount of capital is a nominal amount, there is no main cash flow. The formula for calculating the settlement amount (settlement sums) under the advance interest rate agreement is as follows: an advance interest rate agreement (FRA) is ideal for an investor or company that wants to set an interest rate. They allow participants to subsequently make a known interest payment and receive an unknown interest payment. This helps protect investors from the volatility of future interest rate movements. With the conclusion of a FRA, the parties agree on an interest rate for a given period starting at a future date, based on the nominal amount indicated at the beginning of the contract. The advance rate agreement expires in 12 months on June 12, 20X9; The duration of the contract is therefore 183 days. Suppose the 6-month LIBOR is set at 2.32250% on the date of fixation. The billing amount is $25,082.92. P being the nominal amount (also called nominal amount), the reference rate (annualized), the rFRA the contract rate (annualized), t a contract duration in days and T an annual basis in days (360 USD and EUR, 365 for GBP).
Unlike most futures contracts, the settlement date is at the beginning of the contract term and not at the end of the contract, since on that date the reference rate is already known, which makes it possible to determine liability. The requirement that payment be made sooner rather than later reduces credit risk for both parties. The duration of the contract is the date on which the duration of the contract ends. The FRA period is usually indicated with regard to the date of the contract: number of months before the settlement date × number of months until the expiry. . . .