Forward Rate Agreements
Find the fixed rate on a forward rate agreement from the money-market rates to its start and end, value it when rates move, and work out who pays whom at settlement.
Learning focus: the FRA rate is the forward rate that makes borrowing to the end equal to borrowing to the start and rolling over, so the long (who pays fixed) gains when the floating rate comes in higher.
Rates for 60 and 150 days.
The long pays the fixed FRA rate and receives the floating rate. If the FRA rate for the same period is now higher than the one agreed, the long's contract is worth the extra interest, discounted to today.
The rate is set and the payment made at the start of the FRA period (advance set, advance settled), so the interest difference owed at the end is discounted at the reference rate over the period.
The payment is zero when the reference rate equals the FRA rate. Above it the short pays the long; below it the long pays the short. The line bends slightly because a higher reference rate also discounts the payment more.