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Discuss Forward Rate Agreement

Many banks and large corporations will use FRAs to hedge future interest rate or foreign exchange risks. The buyer insures against the risk of rising interest rates, while the seller hedges against the risk of falling interest rates. Other parties who use interest rate agreements in the future are speculators who only want to make bets on future changes in the direction of interest rates. [2] Development exchange operations in the 1980s offered organizations an alternative to FRA for hedging and speculation. A FRA is an agreement between you and the bank to exchange the net difference between a fixed rate and a variable rate. This exchange is based on the nominal amount you need for the nominated duration. The net spread between the two interest rates is applied to the underlying loan. A company learns that it must borrow $1,000,000 in six months for a period of 6 months. The rate at which it can borrow today is 6 months LIBOR plus 50 basis points. Let`s also assume that the 6-month LIBOR currently stands at 0.89465%, but the company treasurer thinks it could rise up to 1.30% in the coming months.

Suppose a company wants to borrow a sum of Rs. 1 crore for a period of six months from today. Her main concern is that the six-month interest rate could rise in three months, and that is why she now wants to consolidate an interest rate for a future loan commitment. For example, XYZ Corporation, which borrowed on the basis of variable interest rates, estimated that interest rates would likely rise. .