Forward rate agreement (FRA) is a contract between two parties, where one party agrees to pay the other party a fixed interest rate on a notional amount for a specified period. The FRA is used to hedge against interest rate risk, where one party is looking to lock in a fixed interest rate for a future settlement date.
In an FRA contract, there are two parties involved – the FRA buyer and the FRA receiver. The FRA buyer is the party that agrees to pay a fixed interest rate on a notional amount for a specified period, while the FRA receiver is the party that receives the fixed interest rate payment.
In this article, we will focus on the FRA receiver and their role in the FRA contract.
The FRA receiver is typically a borrower who is looking to hedge against the risk of rising interest rates. By entering into an FRA contract, the FRA receiver is able to lock in a fixed interest rate for a future settlement date, which gives them certainty over their future interest payments.
For example, let`s say that a borrower is looking to take out a loan six months from now, and they are concerned that interest rates may rise in the meantime. To hedge against this risk, the borrower can enter into an FRA contract with a bank, where they agree to receive a fixed interest rate on a notional amount for a six-month period.
If interest rates do rise during this six-month period, the borrower is protected because they have locked in a fixed interest rate with the FRA contract. However, if interest rates fall, the borrower will still have to pay the fixed interest rate agreed upon in the FRA contract, which may result in a higher interest rate payment than if they had not entered into the FRA contract.
The FRA receiver is typically a borrower who is looking to mitigate the risk of rising interest rates, but it can also be a speculator who is looking to profit from interest rate movements. For example, a speculator may enter into an FRA contract with the expectation that interest rates will rise, which would result in a higher fixed interest rate payment being received.
In conclusion, the FRA receiver plays an important role in the FRA contract by receiving fixed interest rate payments on a notional amount for a specified period. By entering into an FRA contract, the FRA receiver is able to hedge against the risk of rising interest rates and protect themselves from future interest rate volatility.