60.F: COMPARE INTEREST RATE OPTIONS WITH FORWARD RATE AGREEMENTS (FRAS)

Question 1

Options Contracts and Forward Rate Agreements

Answer 1

• A Forward Rate agreement is a forward agreement, so it is a contract you
are obligated to fulfill.
• An interest rate option if bought allows you to exercise the contract ONLY if
you gain from the contract.
• You pay upfront for an option if you buy it
• You are paid upfront for an option if you write it.
• If you write an option you are obligated to fulfill contract, but your maximum
gain is the premium you receive in the beginning.
• FRAs may be set up without any payment initially, just like a normal
forward contract.