Forward Rate Agreement (FRA) - Financial definition
Concise definition of the term Forward Rate Agreement
An FRA is an agreement between two parties who seek to protect themselves against future movements in interest rates. By entering into an FRA, both parties lock in an interest rate on a specified principal amount for a stated period of time starting on a future settlement date.
Comprehensive definition of the term Forward Rate Agreement
The buyer of the FRA enters into the contract to protect himself from an increase in interest rates. When a company believes that interest rates may rise, an FRA allows it to fix its future borrowing cost.
The seller of the FRA wants to protect himself from a future decline in interest rates. This strategy is used by investors who want to secure the return obtained on a future deposit.
FRAs are settled by a single, netted cash flow on settlement date, which is the start date of the notional loan or deposit. The amount of the settlement payment is determined by the interest rate differential between the prevailing market rate on settlement date and the rate specified in the FRA contract. There is no exchange of principal amounts.