In the example, after the increase in interest rates from the contractual rate of 6.25%, the buyer receives from the seller the amount of compensation to offset the higher cost of the debt. The defect pays if the interest had fallen, the buyer would have had to pay the amount to the seller to reward him for the lower-than-expected return on potential investments. Equation 1.1 is set so that a positive settlement amount determines the seller`s payment to the buyer; on the contrary, a negative value encourages the buyer to pay the seller. It begins from the date of trading at which the two parties to the agreement set each mandate. Suppose the trading date is Monday, April 12, 1993 and the two parties negotiate an FRA 1X4 on $500 of $lm capital with a rate of 6.25%. The currency of the contract is therefore the dollar, the amount of the contract is one million and the contract rate is 6.25%. The term 1X4 refers to a one-month period between the normal date of the spot and the settlement date and a four-month period between the date of the spot and the maturity of the potential liability. The Forward Rate Agreement (FRA) is a derivative contract whereby the parties agree to exchange at the end of the contract the difference between a fixed rate (or term interest rate) and a variable market rate (or settlement rate) multiplied by the duration of the contract and the fictitious capital. The delay between the date of the contract`s conclusion and the date on which interest begins is called additional time that allows you to immunize against future changes in the interest rate. The seller is receiving the fixed rate payment and the variable rate payment, while the buyer withdraws the variable rate payment and makes the fixed rate payment. Since both contractors are required to provide their own services, fra is a symmetrical derivatives contract.
Fra allows immunization against future interest rate changes; it is indeed possible to invest or borrow at a later time at the current forward interest rate. The sale of fra allows a person who must make a future investment to block the current game.