A forward rate agreement (or an FRA) is a cash-settled forward on a short-term loan. It is similar to a Vanilla Swap with a number of differences:
An FRA always consists of only one payment.
An FRA has a different settlement convention. In a vanilla swap, payment is made at the end of each accrual period. In an FRA, the contract is settled (and the payment made) on the first day of the underlying loan, which is also called the settlement (or payment) date.
The payment is actually the discounted amount (because it is paid on the first day of the underlying loan) and normally only the net amount is exchanged.
Example of a Forward Rate Agreement
Consider an FRA in which:
The trade date (today) is 2 November 2009
The start date is 16 December 2009
The end date is 17 May 2010
The fixed rate according to which the fixed rate payer will pay interest is determined and fixed at the trade date.
On the payment date (which is the same as the start date), i.e., 16 December 2009:
The fixed rate payer pays the interest on the notional as calculated for the duration of the underlying loan (from 16 December 2010 to 17 May 2010), according to the fixed rate set on the trade date.
The floating rate payer pays the interest on the notional as calculated for the duration of the underlying loan (from 16 December 2010 to 17 May 2010). This is calculated according to the floating rate fixed on the fixing date, which is a number of days before the payment date as determined by the fixing delay setting.
Pricing a Forward Rate Agreement in SDX Interest Rates
When pricing an FRA in SDX Interest Rates, in addition to the standard fields for vanilla swaps the following must be specified:
Start Date
This is the start of the instrument, as well as the date on which the payments are to be made by each party.
End Date
This is the end date of the instrument, i.e., of the accrual period.
Fixing Date
This is the date on which the floating rate is fixed.
You must specify the start, end and fixing dates using the Tenor field. For example, to specify that the underlying loan is to start in 3 months time and expire in 9 months time, enter 3m9m. The Start Date, End Date and Fixing Date fields are then automatically calculated, and the Tenor field is updated to just show 6m, i.e., the duration of the loan.