Forward Rate Agreement
Also known as: FRA
Lock today the interest rate for a loan that starts in the future — one period, one payment, pure simplicity.
1 · SnapshotThe one idea to remember
2 · BeginnerWhat is it, really?
A forward rate agreement fixes, today, the interest rate for a single borrowing period that begins in the future — say, the 3-month rate starting 6 months from now (dealers call that a "6x9 FRA").
No loan actually happens. At the start of the period, the agreed rate is compared with the actual market rate, and one side pays the other the difference in cash. A borrower who feared rising rates and bought the FRA gets compensated exactly when their real borrowing costs more.
The FRA is the simplest possible rate derivative — a single period, a single cash flow — which makes it the perfect classroom for understanding its big sibling, the interest rate swap: a swap is just a chain of FRAs.
Point at a line to pick it out from the others.
only if a condition is metnot a payment
An FRA settles at the beginning of the period it covers, discounted — which surprises people who expect it to behave like a coupon.
On the trade date
- The buyer → The seller Agreed for a stated notional between two future dates. Nothing is paid.
On the fixing date
- The seller → The buyer The published rate for the period is observed. The whole contract turns on this one number.
On the settlement date
- The seller → The buyer Paid as a single net amount and discounted back, because it is being paid at the start of the period rather than at the end of it.
- The buyer → The seller The same calculation with the sign reversed. There is no exchange of principal in either direction.
one net payment, made early and discounted
- Asset class
- Rates derivatives
- Instrument type
- Single-period forward
- Traded
- OTC (largely replaced by RFR futures/swaps)
- Typical users
- Banks, corporates, curve traders
Which risks decide the outcome
Not how risky this is, and not a rating — there is deliberately no total. It says which of five failure modes drives what happens here, in the same order on all 129 products so they can be compared. This publication's own reading; see the notice below.
- Marketdecides it
- Creditmatters
- Liquiditymatters
- Fundingbarely applies
- Operationalbarely applies
What decides it here. One net payment on one date. Simple enough that the risk really is just where the index fixes, plus whoever is on the other side.
3 · IntermediateHow it works in practice
Mechanics of a 6x9 FRA
- Trade date: agree rate \(K\) (say 3.50%) on notional \(N\) for the period from month 6 to month 9.
- Fixing: at month 6, observe the reference rate \(r\) (historically LIBOR/EURIBOR; now term RFRs or the compounded rate at period end).
- Settlement: buyer (rate payer) receives \(N(r-K)\delta\), discounted if paid upfront at fixing.
Reading forward rates
FRA rates are the market's implied forwards: if 6-month money costs 3.0% and 9-month money 3.2%, the 6x9 rate must make the two routes equivalent — roughly 3.6%. A steep curve means high forwards, i.e. the market charges heavily for future rate risk.
Uses
- Corporate hedging: fix the rate on the next refinancing or deposit rollover.
- Bank gap management: patch single-period mismatches between assets and liabilities.
- Speculation on meetings: pre-reform, FRAs were precise instruments on individual central-bank moves; that role now lives in STIR futures and meeting-dated OIS.
4 · AdvancedPricing & valuation
Forward rate by no-arbitrage
Replication (borrow long, lend short) forces the FRA rate to the curve-implied forward:
What the symbols mean
- ta point in time
- deltaa small change in whatever follows
- Pa price, or a present value
Valuation after inception: \(V = N\,\delta\,\big(f_{now} - K\big) P(0, t_2)\) for the buyer — a seasoned FRA is just the discounted move in the forward.
The convexity footnote
Classic FRAs settle the discounted payoff at \(t_1\) (start of period), while the natural payoff occurs at \(t_2\); under rate-dependent discounting this timing difference creates a small convexity adjustment between FRA rates and their futures-market cousins:
What the symbols mean
- ta point in time
- Fthe forward or futures price
- Ra return
- sigmavolatility, the standard deviation of returns
— futures gain from margining when rates and P&L correlate, so futures-implied rates sit above FRA/forward rates; the adjustment grows with maturity squared and volatility.
Post-reform status
With IBORs gone, single-period exposure is now traded as short OIS, RFR futures, or "single-period swaps" (SPS) — economically FRAs on compounded overnight rates, settled in arrears (no discounting quirk). The FRA's conceptual role — atomic unit of the curve — is unchanged: any curve bootstrap still conceptually decomposes swaps into these single-period forwards.
The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.
5 · Desk notesHow practitioners think about it
Now say it back
Close the page and give Forward Rate Agreement in four sentences. It takes a minute and it is the only way to find out whether reading it was enough.
- Who wants what — two parties wanted opposite things badly enough to write it down.
- What the contract obliges, and when — not the payoff; the obligation.
- Where the money comes from — name the source, or you have described a hope.
- What makes it lose — the ordinary way, not the dramatic one.
Put Forward Rate Agreement beside any other instrument →
Where this instrument shows up elsewhere
- MediumCentral Banks & Monetary PolicyConceptsOne overnight rate, set by a committee, propagating into every price on this site
- MediumWhich Desk Trades WhatPrepEleven trading seats and six that sit next to them: what each one actually touches, the single number it lives by,…