{"id":8437,"date":"2020-12-15T08:28:22","date_gmt":"2020-12-15T08:28:22","guid":{"rendered":"https:\/\/analystprep.com\/blog\/?p=8437"},"modified":"2026-05-12T15:08:24","modified_gmt":"2026-05-12T15:08:24","slug":"demystifying-forward-rate-agreements","status":"publish","type":"post","link":"https:\/\/analystprep.com\/blog\/demystifying-forward-rate-agreements\/","title":{"rendered":"Demystifying Forward Rate Agreements (Calculations for CFA\u00ae and FRM\u00ae Exams)"},"content":{"rendered":"\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"FAQPage\",\n  \"mainEntity\": [\n    {\n      \"@type\": \"Question\",\n      \"name\": \"What is a Forward Rate Agreement (FRA)?\",\n      \"acceptedAnswer\": {\n        \"@type\": \"Answer\",\n        \"text\": \"A Forward Rate Agreement (FRA) is a financial contract that determines the interest rate to be applied to a notional loan or deposit starting at a future date. It's commonly used for hedging interest rate risks.\"\n      }\n    },\n    {\n      \"@type\": \"Question\",\n      \"name\": \"How is a Forward Rate Agreement (FRA) calculated?\",\n      \"acceptedAnswer\": {\n        \"@type\": \"Answer\",\n        \"text\": \"An FRA is calculated using the formula: [(Forward Rate - Contract Rate) \u00d7 Notional Amount \u00d7 (Days\/360)] \/ [1 + (Forward Rate \u00d7 (Days\/360))]. This helps determine the settlement amount based on rate differences.\"\n      }\n    },\n    {\n      \"@type\": \"Question\",\n      \"name\": \"What is the difference between an FRA and a Forward Contract?\",\n      \"acceptedAnswer\": {\n        \"@type\": \"Answer\",\n        \"text\": \"FRAs are used to hedge interest rate risks and are cash-settled, while Forward Contracts hedge price risks for commodities or currencies and typically involve physical delivery.\"\n      }\n    },\n    {\n      \"@type\": \"Question\",\n      \"name\": \"Are FRAs tested in the CFA and FRM exams?\",\n      \"acceptedAnswer\": {\n        \"@type\": \"Answer\",\n        \"text\": \"Yes, Forward Rate Agreements (FRAs) are commonly tested in both CFA and FRM exams, particularly under fixed income and derivatives topics. Candidates should know their valuation and application.\"\n      }\n    },\n    {\n      \"@type\": \"Question\",\n      \"name\": \"When should I use an FRA instead of a Forward Contract?\",\n      \"acceptedAnswer\": {\n        \"@type\": \"Answer\",\n        \"text\": \"Use an FRA when you want to lock in future interest rates and manage borrowing or lending costs. Forward Contracts are better suited for locking in asset prices, such as currencies or commodities.\"\n      }\n    }\n  ]\n}\n<\/script>\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@graph\": [\n    {\n      \"@type\": \"ImageObject\",\n      \"url\": \"https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/FRA-22.png\",\n      \"contentUrl\": \"https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/FRA-22.png\",\n      \"caption\": \"Demystifying forward rate agreements\",\n      \"width\": 880,\n      \"height\": 325,\n      \"fileFormat\": \"image\/png\",\n      \"copyrightNotice\": \"\u00a9 2024 AnalystPrep\",\n      \"acquireLicensePage\": \"https:\/\/analystprep.com\/license-info\",\n      \"creditText\": \"AnalystPrep Design Team\",\n      \"creator\": {\n        \"@type\": \"Organization\",\n        \"name\": \"AnalystPrep\",\n        \"url\": \"https:\/\/analystprep.com\"\n      }\n    },\n    {\n      \"@type\": \"ImageObject\",\n      \"url\": \"https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/Example-3by9.png\",\n      \"contentUrl\": \"https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/Example-3by9.png\",\n      \"caption\": \"Demystifying forward rate agreements\",\n      \"width\": 880,\n      \"height\": 325,\n      \"fileFormat\": \"image\/png\",\n      \"copyrightNotice\": \"\u00a9 2024 AnalystPrep\",\n      \"acquireLicensePage\": \"https:\/\/analystprep.com\/license-info\",\n      \"creditText\": \"AnalystPrep Design Team\",\n      \"creator\": {\n        \"@type\": \"Organization\",\n        \"name\": \"AnalystPrep\",\n        \"url\": \"https:\/\/analystprep.com\"\n      }\n    },\n    {\n      \"@type\": \"ImageObject\",\n      \"url\": \"https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/2by3-1024x664.png\",\n      \"contentUrl\": \"https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/2by3-1024x664.png\",\n      \"caption\": \"Demystifying forward rate agreements\",\n      \"width\": 1024,\n      \"height\": 664,\n      \"fileFormat\": \"image\/png\",\n      \"copyrightNotice\": \"\u00a9 2024 AnalystPrep\",\n      \"acquireLicensePage\": \"https:\/\/analystprep.com\/license-info\",\n      \"creditText\": \"AnalystPrep Design Team\",\n      \"creator\": {\n        \"@type\": \"Organization\",\n        \"name\": \"AnalystPrep\",\n        \"url\": \"https:\/\/analystprep.com\"\n      }\n    },\n    {\n      \"@type\": \"ImageObject\",\n      \"url\": \"https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/FRA-cropped-1024x322.png\",\n      \"contentUrl\": \"https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/FRA-cropped-1024x322.png\",\n      \"caption\": \"Demystifying forward rate agreements\",\n      \"width\": 1024,\n      \"height\": 322,\n      \"fileFormat\": \"image\/png\",\n      \"copyrightNotice\": \"\u00a9 2024 AnalystPrep\",\n      \"acquireLicensePage\": \"https:\/\/analystprep.com\/license-info\",\n      \"creditText\": \"AnalystPrep Design Team\",\n      \"creator\": {\n        \"@type\": \"Organization\",\n        \"name\": \"AnalystPrep\",\n        \"url\": \"https:\/\/analystprep.com\"\n      }\n    },\n    {\n      \"@type\": \"ImageObject\",\n      \"url\": \"https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/Last-example-FRA-1024x340.png\",\n      \"contentUrl\": \"https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/Last-example-FRA-1024x340.png\",\n      \"caption\": \"Demystifying forward rate agreements\",\n      \"width\": 1024,\n      \"height\": 340,\n      \"fileFormat\": \"image\/png\",\n      \"copyrightNotice\": \"\u00a9 2024 AnalystPrep\",\n      \"acquireLicensePage\": \"https:\/\/analystprep.com\/license-info\",\n      \"creditText\": \"AnalystPrep Design Team\",\n      \"creator\": {\n        \"@type\": \"Organization\",\n        \"name\": \"AnalystPrep\",\n        \"url\": \"https:\/\/analystprep.com\"\n      }\n    }\n  ]\n}\n<\/script>\n\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"QAPage\",\n  \"mainEntity\": {\n    \"@type\": \"Question\",\n    \"name\": \"Example 1: Understanding FRAs\",\n    \"text\": \"A 3 \u00d7 9 FRA refers to:\\n1. A 90-day LIBOR loan starting 270 days from now.\\n2. 270-day LIBOR loan starting 90 days from now.\\n3. 180-day LIBOR loan starting 90 days from now.\\n4. 270-day LIBOR loan starting 180 days from now.\",\n    \"answerCount\": 1,\n    \"upvoteCount\": 0,\n    \"dateCreated\": \"2020-12-15T00:00:00+00:00\",\n    \"author\": {\n      \"@type\": \"Organization\",\n      \"name\": \"AnalystPrep\"\n    },\n    \"acceptedAnswer\": {\n      \"@type\": \"Answer\",\n      \"text\": \"The correct answer is choice 3 (C). A 3 \u00d7 9 FRA represents a 180-day LIBOR loan starting 90 days from now, because the first number indicates when the loan starts and the second indicates when it ends.\",\n      \"dateCreated\": \"2020-12-15T00:00:00+00:00\",\n      \"upvoteCount\": 0,\n      \"url\": \"https:\/\/analystprep.com\/blog\/demystifying-forward-rate-agreements\/#example-1-fra\",\n      \"author\": {\n        \"@type\": \"Organization\",\n        \"name\": \"AnalystPrep\"\n      }\n    }\n  }\n}\n<\/script>\n\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"QAPage\",\n  \"mainEntity\": {\n    \"@type\": \"Question\",\n    \"name\": \"Example 2: FRA Valuation\",\n    \"text\": \"Suppose we have a 1 \u00d7 4 FRA with a notional principal of $1 million. At settlement, the 90-day LIBOR is 6% and the FRA contract rate is 5.5%. What is the value of the FRA to the long position?\",\n    \"answerCount\": 1,\n    \"upvoteCount\": 0,\n    \"dateCreated\": \"2020-12-15T00:00:00+00:00\",\n    \"author\": {\n      \"@type\": \"Organization\",\n      \"name\": \"AnalystPrep\"\n    },\n    \"acceptedAnswer\": {\n      \"@type\": \"Answer\",\n      \"text\": \"Because the settlement rate (6%) exceeds the FRA rate (5.5%), the FRA is worth a positive amount to the long. The payment equals: \\nPayment = 1,000,000 \u00d7 ((0.06 \u2212 0.055) \u00d7 90\/360) \u00f7 [1 + 0.06 \u00d7 90\/360] \u2248 $1,231.53 received by the long at settlement.\",\n      \"dateCreated\": \"2020-12-15T00:00:00+00:00\",\n      \"upvoteCount\": 0,\n      \"url\": \"https:\/\/analystprep.com\/blog\/demystifying-forward-rate-agreements\/#example-2-fra-valuation\",\n      \"author\": {\n        \"@type\": \"Organization\",\n        \"name\": \"AnalystPrep\"\n      }\n    }\n  }\n}\n<\/script>\n\n\n\n<iframe loading=\"lazy\" width=\"560\" height=\"315\"\n  src=\"https:\/\/www.youtube.com\/embed\/0NpydeNNufM\"\n  title=\"YouTube video player\"\n  frameborder=\"0\"\n  allow=\"accelerometer; autoplay; clipboard-write; encrypted-media; gyroscope; picture-in-picture; web-share\"\n  referrerpolicy=\"strict-origin-when-cross-origin\"\n  allowfullscreen>\n<\/iframe>\n\n\n\n<p>A forward rate agreement (FRA) is a cash-settled over-the-counter (OTC) contract between two counterparties, where the <em>buyer<\/em> is borrowing (and the <em>seller<\/em> is lending) a&nbsp;notional&nbsp;sum at a fixed interest rate (the FRA rate) and for a specified period starting at an agreed date in the future.<\/p>\n\n\n\n<p>The purpose of FRA is to lock in borrowing or a lending rate for some time in the future. Typically, it involves two parties exchanging a fixed interest rate for a floating rate.<\/p>\n\n\n\n<!-- Top CTA: Place just after the intro -->\n<div style=\"margin:24px 0;\">\n  <a href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" rel=\"noopener noreferrer\" style=\"display:block; width:100%; box-sizing:border-box; text-align:center; background:#1a73e8; color:#ffffff; padding:12px 20px; border-radius:999px; font-weight:600; text-decoration:none; font-size:16px; line-height:1.4;\">\n    Learn forward rate agreements with our Free Trial\n  <\/a>\n<\/div>\n\n\n<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_82_2 counter-hierarchy ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">Table of Contents<\/p>\n<span class=\"ez-toc-title-toggle\"><a href=\"#\" class=\"ez-toc-pull-right ez-toc-btn ez-toc-btn-xs ez-toc-btn-default ez-toc-toggle\" aria-label=\"Toggle Table of Content\"><span class=\"ez-toc-js-icon-con\"><span class=\"\"><span class=\"eztoc-hide\" style=\"display:none;\">Toggle<\/span><span class=\"ez-toc-icon-toggle-span\"><svg style=\"fill: #999;color:#999\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" class=\"list-377408\" width=\"20px\" height=\"20px\" viewBox=\"0 0 24 24\" fill=\"none\"><path d=\"M6 6H4v2h2V6zm14 0H8v2h12V6zM4 11h2v2H4v-2zm16 0H8v2h12v-2zM4 16h2v2H4v-2zm16 0H8v2h12v-2z\" fill=\"currentColor\"><\/path><\/svg><svg style=\"fill: #999;color:#999\" class=\"arrow-unsorted-368013\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" width=\"10px\" height=\"10px\" viewBox=\"0 0 24 24\" version=\"1.2\" baseProfile=\"tiny\"><path d=\"M18.2 9.3l-6.2-6.3-6.2 6.3c-.2.2-.3.4-.3.7s.1.5.3.7c.2.2.4.3.7.3h11c.3 0 .5-.1.7-.3.2-.2.3-.5.3-.7s-.1-.5-.3-.7zM5.8 14.7l6.2 6.3 6.2-6.3c.2-.2.3-.5.3-.7s-.1-.5-.3-.7c-.2-.2-.4-.3-.7-.3h-11c-.3 0-.5.1-.7.3-.2.2-.3.5-.3.7s.1.5.3.7z\"\/><\/svg><\/span><\/span><\/span><\/a><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/analystprep.com\/blog\/demystifying-forward-rate-agreements\/#An_FRA_involves_Two_Counterparties\" >An FRA involves Two Counterparties:<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/analystprep.com\/blog\/demystifying-forward-rate-agreements\/#Naming_Convention_FRM_Exam\" >Naming Convention (FRM Exam)<\/a><ul class='ez-toc-list-level-4' ><li class='ez-toc-heading-level-4'><ul class='ez-toc-list-level-4' ><li class='ez-toc-heading-level-4'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/analystprep.com\/blog\/demystifying-forward-rate-agreements\/#Example_1_Understanding_FRAs\" >Example 1: Understanding FRAs\u00a0<\/a><\/li><\/ul><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/analystprep.com\/blog\/demystifying-forward-rate-agreements\/#FRA_vs_Forwards\" >FRA vs. Forwards<\/a><ul class='ez-toc-list-level-4' ><li class='ez-toc-heading-level-4'><ul class='ez-toc-list-level-4' ><li class='ez-toc-heading-level-4'><a class=\"ez-toc-link ez-toc-heading-5\" href=\"https:\/\/analystprep.com\/blog\/demystifying-forward-rate-agreements\/#Illustration\" >Illustration<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-4'><a class=\"ez-toc-link ez-toc-heading-6\" href=\"https:\/\/analystprep.com\/blog\/demystifying-forward-rate-agreements\/#Example_2_FRA_Valuation\" >Example 2: FRA Valuation<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-4'><a class=\"ez-toc-link ez-toc-heading-7\" href=\"https:\/\/analystprep.com\/blog\/demystifying-forward-rate-agreements\/#Solution\" >Solution<\/a><\/li><\/ul><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-8\" href=\"https:\/\/analystprep.com\/blog\/demystifying-forward-rate-agreements\/#Why_Forward_Rate_Agreements_Matter_in_CFA_Level_I\" >Why Forward Rate Agreements Matter in CFA Level I<\/a><\/li><\/ul><\/nav><\/div>\n<h2><span class=\"ez-toc-section\" id=\"An_FRA_involves_Two_Counterparties\"><\/span><span class=\"primary-color\"><br \/>An FRA involves Two Counterparties:<\/span><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<ul>\n<li><strong>The borrower: <\/strong>The <em>long<\/em> pays a fixed rate and receives floating rates. Think of &#8220;buying money.&#8221; If LIBOR rises, the long will gain.<\/li>\n<li><strong>The lender:<\/strong> The <em>short <\/em>pays a floating rate and receives a fixed rate. Think of &#8220;selling money.&#8221; If LIBOR falls, the short will gain.<\/li>\n<\/ul>\n<p>The <strong>FRA buyer<\/strong> enters into the contract to protect itself from a future increase in interest rates; the <strong>seller<\/strong> of the FRA wants to protect itself from a future decline in interest rates.<\/p>\n<p><blockquote class=\"wp-embedded-content\" data-secret=\"znnqdyOi12\"><a href=\"https:\/\/analystprep.com\/shop\/frm-part-1-and-part-2-complete-course-by-analystprep\/\">FRM Part 1 and Part 2 Complete Online Course<\/a><\/blockquote><iframe loading=\"lazy\" class=\"wp-embedded-content\" sandbox=\"allow-scripts\" security=\"restricted\" style=\"position: absolute; visibility: hidden;\" title=\"&#8220;FRM Part 1 and Part 2 Complete Online Course&#8221; &#8212; AnalystPrep\" src=\"https:\/\/analystprep.com\/shop\/frm-part-1-and-part-2-complete-course-by-analystprep\/embed\/#?secret=9oGfygDdLH#?secret=znnqdyOi12\" data-secret=\"znnqdyOi12\" width=\"600\" height=\"338\" frameborder=\"0\" marginwidth=\"0\" marginheight=\"0\" scrolling=\"no\"><\/iframe><\/p>\n<h2><span class=\"ez-toc-section\" id=\"Naming_Convention_FRM_Exam\"><\/span><span class=\"primary-color\">Naming Convention (FRM Exam)<\/span><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>FRAs are denoted in the form of &#8220;<em>X<\/em> \u00d7 <em>Y<\/em>,&#8221; where <em>X<\/em> and <em>Y<\/em> are months. So, a 1 \u00d7 4 FRA is called &#8220;1 by 4&#8221;.<\/p>\n<p>Implying that:<\/p>\n<p>A 1 \u00d7 4 FRA expires in 30 days (one month), and the theoretical loan is for a time period of the difference between 1 and 4 (three months = 90 days). That is, a three-month Libor determines the FRA&#8217;s payoff, but the FRA expires in one month.<\/p>\n<p><img loading=\"lazy\" decoding=\"async\" class=\"alignnone wp-image-8458 size-full\" style=\"max-width: 100%;\" src=\"https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/FRA-22.png\" alt=\"\" width=\"880\" height=\"325\" srcset=\"https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/FRA-22.png 880w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/FRA-22-300x111.png 300w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/FRA-22-768x284.png 768w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/FRA-22-400x148.png 400w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/FRA-22-484x179.png 484w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/FRA-22-570x211.png 570w\" sizes=\"auto, (max-width: 880px) 100vw, 880px\" \/><\/p>\n<h4><span class=\"ez-toc-section\" id=\"Example_1_Understanding_FRAs\"><\/span><span class=\"primary-color\">Example 1: Understanding FRAs\u00a0<\/span><span class=\"ez-toc-section-end\"><\/span><\/h4>\n<p><strong>A 3 \u00d7 9 FRA refers to:<\/strong><\/p>\n<ol type=\"A\">\n<li>A 90-day LIBOR loan starting 270 days from now.<\/li>\n<li>270-day LIBOR loan starting 90 days from now.<\/li>\n<li>180-day LIBOR loan starting 90 days from now.<\/li>\n<li>270-day LIBOR loan starting 180 days from now.<\/li>\n<\/ol>\n<p><strong><span class=\"primary-color\">Solution<\/span><\/strong><\/p>\n<p>The correct answer is <strong>C<\/strong>.<\/p>\n<p>3-by-9 means a 180-day LIBOR loan starting 90 days from now.<\/p>\n<p><img loading=\"lazy\" decoding=\"async\" class=\"alignnone wp-image-8461 size-full\" style=\"max-width: 100%;\" src=\"https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/Example-3by9.png\" alt=\"\" width=\"880\" height=\"325\" srcset=\"https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/Example-3by9.png 880w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/Example-3by9-300x111.png 300w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/Example-3by9-768x284.png 768w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/Example-3by9-400x148.png 400w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/Example-3by9-484x179.png 484w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/Example-3by9-570x211.png 570w\" sizes=\"auto, (max-width: 880px) 100vw, 880px\" \/><\/p>\n<h2><span class=\"ez-toc-section\" id=\"FRA_vs_Forwards\"><\/span><span class=\"primary-color\">FRA vs. Forwards<\/span><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>The forward rate specified in the FRA is compared with the current LIBOR rate, where:<\/p>\n<ul>\n<li style=\"list-style-type: none;\">\n<ul>\n<li>If the current LIBOR is <em>greater<\/em> than the FRA rate, the long can effectively borrow at a below-market rate. The long receives a payment based on the difference between the two rates.<\/li>\n<li>However, if the current LIBOR was lower than the FRA rate, then long makes a payment to the short. The payment ends up compensating for any change in interest rates since the contract date<\/li>\n<\/ul>\n<\/li>\n<\/ul>\n<h4><span class=\"ez-toc-section\" id=\"Illustration\"><\/span><span class=\"primary-color\">Illustration<\/span><span class=\"ez-toc-section-end\"><\/span><\/h4>\n<p><img loading=\"lazy\" decoding=\"async\" class=\"alignnone wp-image-8493 size-full\" style=\"max-width: 100%;\" src=\"https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/2by3.png\" alt=\"\" width=\"1139\" height=\"739\" srcset=\"https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/2by3.png 1139w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/2by3-300x195.png 300w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/2by3-768x498.png 768w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/2by3-1024x664.png 1024w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/2by3-400x260.png 400w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/2by3-830x540.png 830w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/2by3-484x314.png 484w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/2by3-570x370.png 570w\" sizes=\"auto, (max-width: 1139px) 100vw, 1139px\" \/><\/p>\n<h4><span class=\"ez-toc-section\" id=\"Example_2_FRA_Valuation\"><\/span><span class=\"primary-color\">Example 2: FRA Valuation<\/span><span class=\"ez-toc-section-end\"><\/span><\/h4>\n<p>Suppose we have a 1 x 4 FRA with a notional principal of $1 million. At contract expiration, the 90-day LIBOR at settlement is 6% and the contract rate is 5.5%.<\/p>\n<p>The value of the FRA at maturity is\u00a0<em>closest to<\/em>:<\/p>\n<h4><span class=\"ez-toc-section\" id=\"Solution\"><\/span><span class=\"primary-color\">Solution<\/span><span class=\"ez-toc-section-end\"><\/span><\/h4>\n<p>$$ \\begin{aligned} &amp;\\begin{array}{c} \\text{Payment} \\\\ \\text{to the Long} \\end{array} = \\text{Notional principal} \\times \\frac{(\\text{Rate at settlement} &#8211; \\text{FRA rate}) \\times \\frac{\\text{Days}}{360}}{1 + \\text{Rate at settlement} \\times \\frac{\\text{Days}}{360}} \\end{aligned} $$<\/p>\n<p><img loading=\"lazy\" decoding=\"async\" class=\"alignnone wp-image-8483 size-full\" style=\"max-width: 100%;\" src=\"https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/FRA-cropped.png\" alt=\"\" width=\"1295\" height=\"407\" srcset=\"https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/FRA-cropped.png 1295w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/FRA-cropped-300x94.png 300w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/FRA-cropped-768x241.png 768w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/FRA-cropped-1024x322.png 1024w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/FRA-cropped-400x126.png 400w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/FRA-cropped-484x152.png 484w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/FRA-cropped-570x179.png 570w\" sizes=\"auto, (max-width: 1295px) 100vw, 1295px\" \/><\/p>\n<p>Since the settlement rate is higher (6%) than the contract rate (5.5%), the buyer will be receiving money from the seller. The payment to the long at settlement are as follow:<\/p>\n<p>Interest saving:<\/p>\n<p>$$=(6\\%-5.5\\%)\\times\\frac{90}{360}\\times1\\text{m}=1,250$$<\/p>\n<p>Discounted back 90 days @ 6%:<\/p>\n<p>$$=\\frac{1,250}{[1+\\frac{90}{360}\\times6\\%]}={1,231.53}$$<\/p>\n<p><img loading=\"lazy\" decoding=\"async\" class=\"alignnone wp-image-8496 size-full\" style=\"max-width: 100%;\" src=\"https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/Last-example-FRA.png\" alt=\"\" width=\"1295\" height=\"430\" srcset=\"https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/Last-example-FRA.png 1295w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/Last-example-FRA-300x100.png 300w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/Last-example-FRA-768x255.png 768w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/Last-example-FRA-1024x340.png 1024w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/Last-example-FRA-400x133.png 400w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/Last-example-FRA-484x161.png 484w, https:\/\/analystprep.com\/blog\/wp-content\/uploads\/2020\/12\/Last-example-FRA-570x189.png 570w\" sizes=\"auto, (max-width: 1295px) 100vw, 1295px\" \/><\/p>\n<p>$$ \\begin{array}{l|c|c} \\textbf{Feature} &amp; \\textbf{Forward Rate Agreement (FRA)} &amp; \\textbf{Forward Contract} \\\\ \\hline \\text{Purpose} &amp; \\text{Interest Rate Hedging} &amp; \\text{Price Hedging} \\\\ \\hline \\text{Settlement} &amp; \\text{Cash-Settled} &amp; \\text{Physical Delivery} \\\\ \\hline \\text{Common Use} &amp; \\text{Loans &amp; Borrowing Costs} &amp; \\text{Commodities, FX} \\\\ \\hline \\text{Tested In} &amp; \\text{CFA &amp; FRM Exams} &amp; \\text{CFA &amp; FRM Exams} \\\\ \\end{array} $$ \u00a0<\/p>\n<p><a class=\"cta-button\" href=\"https:\/\/analystprep.com\/shop\/all-3-levels-of-the-cfa-exam-complete-course-by-analystprep\/\" target=\"_blank\" rel=\"noopener\">View Full CFA Course <\/a>\u00a0<\/p>\n\n\n<h2><span class=\"ez-toc-section\" id=\"Why_Forward_Rate_Agreements_Matter_in_CFA_Level_I\"><\/span>Why Forward Rate Agreements Matter in CFA Level I<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n<p>Forward rate agreements are important CFA Level I Derivatives concepts. Candidates may be tested on FRA notation, contract payoffs, settlement values, and how firms hedge future borrowing or lending rates using interest rate derivatives.<\/p>\n\n<p>To strengthen your preparation, explore the <a href=\"https:\/\/analystprep.com\/cfa-level-1\/\" target=\"_blank\">CFA Level I study program<\/a> with practice questions, mock exams, and guided lessons.<\/p>\n\n\n\n<div style=\"text-align:center;margin:40px 0;\">\n  <a href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\"\n     style=\"display:inline-block;padding:14px 26px;background:#4a76d1;color:#fff;border-radius:999px;text-decoration:none;\">\n     Start Free Trial \u2192\n  <\/a>\n  <p style=\"margin-top:10px;\">\n    Learn forward rate agreements, fixed rates, and OTC contracts with clear study tools.\n  <\/p>\n<\/div>\n","protected":false},"excerpt":{"rendered":"<p>A forward rate agreement (FRA) is a cash-settled over-the-counter (OTC) contract between two counterparties, where the buyer is borrowing (and the seller is lending) a&nbsp;notional&nbsp;sum at a fixed interest rate (the FRA rate) and for a specified period starting at&#8230;<\/p>\n","protected":false},"author":4,"featured_media":8494,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[70,71],"tags":[78,86,83],"class_list":["post-8437","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-cfa","category-frm","tag-cfa","tag-demystifying-fra","tag-frm","blog-post","animate"],"acf":[],"post_mailing_queue_ids":[],"_links":{"self":[{"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/posts\/8437","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/users\/4"}],"replies":[{"embeddable":true,"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/comments?post=8437"}],"version-history":[{"count":56,"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/posts\/8437\/revisions"}],"predecessor-version":[{"id":14822,"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/posts\/8437\/revisions\/14822"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/media\/8494"}],"wp:attachment":[{"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/media?parent=8437"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/categories?post=8437"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/tags?post=8437"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}