In this article, I will give an overview of the two main financial products known as interest rate swaps and advance rate agreements. Forward Rate Agreements (FRA) are over-the-counter contracts between parties that determine the interest rate payable at an agreed date in the future. An FRA is an agreement to exchange an interest rate bond on a fictitious amount. The image shows that on each fixing date, the variable rate is determined for the next period. Note: The current value is calculated as an exp (rate for the current period x current period). An interest rate swap is a financial agreement between the parties to exchange fixed or variable payments over a period of time. Now we have to reset FRA payments on time, so we would use the LIBOR set of t until the end of the period (i.e. 5 months from now). So far, we have understood that FRAs help us to make interest rate movements. Step 2) Get FRAt. Now the question will say that the number of days has passed since we entered the FRA, gives you a new set of new rates, and then you ask the current value (i.e. t value). Do you remember how we had ft in our original futures valuation formula? Let us sub in FRAt for Ft.
FRAt is what the new value of FRA would be right now t. It is calculated like any other FRA. We would like to use the same period as our original FRA, only with the new rates provided and adapted for the past part. If our initial FRA0 z.B was a 3×6 FRA (90 days) and 1 month had passed, then we calculate the new 2×5 FRA (90 days) with our new rates. The question may try to confuse you by giving a number of payments that you do not need. Subsequent in our new FRAt in Ft in our initial equation. This is perhaps the most confusing part of the FRA assessment, because it is so easy to choose the wrong prices. In conclusion, there are many ways to think about this problem, but I prefer the analogy with Vt-PV (Ft-F0) because it means I have a memorization formula. Again sub FRA0 for F0, sub FRAt for Ft, discount from the end of the FRA period to t, and time weight all your prices. In finance, a advance rate agreement (FRA) is an interest rate derivative (IRD). In particular, it is a linear IRD with strong associations with interest rate swaps (IRS).