In todays video we will learn about forward interest rates and a derivative called a forward rate agreement or FRA.These classes are all based on the book Trading and Pricing Financial Derivatives, available on Amazon at this link.
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What are Forward Rates?
A forward rate is an interest rate implied for periods of time in the future by zero-coupon bonds. For example, the market implied yield on a three-month Treasury bill three months from now is a forward rate.
If we know what the three-month zero-coupon Treasury bill rate is and what the six-month zero-coupon Treasury bill rate is, we can back out what the market is implying as the yield on a three-month Treasury bill three months from now.
To calculate forward rates we just need the zero-coupon yield curve.
What are Forward Rate Agreements?
A forward rate agreement (FRA) is an over-the-counter agreement to borrow a fixed amount of money at a fixed interest rate at a specified future time period.
Banks and large corporations can use FRAs to hedge future interest rate exposures. The buyer hedges against the risk of rising interest rates, while the seller hedges against the risk of falling interest rates. Speculators can use FRAs to make bets on future changes in interest rates.
Rates in the future will usually be different from the implied rate at the time you entered into a forward-rate-agreement, giving rise to gains or losses on the agreed transaction.
What is an FRA?
An FRA is an abbreviated term for Forward Rate Agreement
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