F DESCRIBE FORWARD RATE AGREEMENTS (FRAS) AND CALCULATE THE GAIN/LOSS ON A FRA;

Question 1

Forward rate agreement description

Answer 1

An interest payment made in $’s, Euribor, or any other currency at a rate appropriate for that currency.

Question 2

FRA gain/loss calculation

Answer 2

FRA payoff formula (gain/loss calculation)

In general, the FRA payoff formula (from the perspective of the party going long) is where forward contract rate represents the rate the two parties agree will be paid and days in underlying rate refers to the number of days to maturity of the instrument on which the underlying rate is based.

Notional Principal [ (coupon rate - dealer quote)(term/360)/time deposit

time deposit = notional / 1+LIBOR (term/360)

or

Notional [ underlying rate at expiration - forward contract rate (days in underlying rate / 360) / 1 + underlying rate at expiration (days in underlying rate / 360)

Question 3

Whats FRA based on?

Answer 3

Global time deposit market, aka euro dollar (a dollar deposited outside U.S., short term insecure loan, charged at LIBOR as the best representative rate on a dollar borrowed by a private, i.e., nongovernmental, high-quality borrower.