A forward rate agreement, abbreviated as FRA, is a contract in which both contract parties agree to a fixed rate K on a principal N to be paid for some future interest period between T and T_. An FRA can be interpreted as an agreement loan to be made in the future with an interest rate already fixed today. The party receiving the loan makes the fixed interest payments. In contrast to bonds, we will refer to this party’s position as a long position in the FRA, whereas the counterparty receiving the interest payments is short in the FRA. A (long) FRA can thus be interpreted as an agreement on two future cash flows: a receipt of the principal N at time T (the loan is made) and a payment at maturity T_ of the FRA in the amount of the principal N compounded at the agreed rate K over the period T_âˆ’T (the loan plus interest is paid back).
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