2. Forwards, Foward Rate Agreements (FRAs) and Contracts for Difference (CFD) Flashcards
What is the definition of a forward
An agreement to buy (or sell) specified quantity, of a specified asset, on a specified future date for a price agreed today.
The forward price in an FX forward is determined by what factors
The interest rate differential between the two currencies
What are important factors in determining the price of a commodities forward
Current interest rate, cost of financing, and storage costs
Equity forward contracts take into consideration what factors
Current interest rate and equity’s dividend yield.
How are forward contracts usually traded
OTC
Can any forward contracts be traded on exchange
Yes. The LME does trade some forwards on exchange for some nonferrous metals and steel
Who are most forwards usually traded with
Banks and investment banks
Outright forwards are a product most commonly traded in which market?
FX market
What does a forward rate agreement (FRA) enable a company to do
Fix an interest rate in advance
By fixing an interest rate in advance, an FRA enables a borrow (or lender) to take a view on what
Whether interest rates are rising or falling
In an FRA is any principal amount actually borrowed or lent?
No
In an FRA cash flows arise from the difference between what
The interest rate fixed at the outset (the fixed rate) and the level of the benchmark rate at a point in time in the future (the floating rate).
What a the benchmark most often used in an FRA
LIBOR
Summarise the six elements of an FRA
- An agreement to buy (or sell)
- An interest rate, which is fixed today,
- Which will be revalued against prevailing market rates using a benchmark,
- Starting on an agreed future date
- For an agreed future period
- Based on an agreed principal amount (nominal amount not transferred).
The party that pays the fixed rate of an FRA is called what
The buyer
The party that receives the fixed rate and pays the floating rating is called what
The seller
On what date is an FRA settled
On the date when the FRA period starts
Because an FRA is settle on the date the FRA period starts, what is it important to remember about the settlement amount
That is is discounted, at current market rates
In an FRA the period over which the interest is calculated is known as the what
Calculation period
Explain the calculation period, what dates does it include
The first day of the calculation period, up but excluding the last day
What is the day count convention for EUR, USD and GBP in an FRA
USD & EUR = 360
GBP = 365
Calculation of the FRA settlement can result in what figures
Positive and negative
Explain a positive FRA figure
Think your rate (as buyer ie the fixed rate) is greater than the floating rate.
Fixed rate - floating rate = positive figure
When positive, you pay the seller
Explain a negative FRA
Think your rate (as buyer ie the fixed rate) is less than the floating rate.
Fixed rate - floating rate = negative figure
When negative - the seller pays you
