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elearning > Forward interest rates

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Learn about the following:

What forward interest rates are and how they are calculated . How forward rate agreements (FRAs) work. The terminology associated with FRAs. How FRAs settle.
How FRAs are used for trading and hedging.

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Course Summary

Forward interest rates menuForward interest rates calculationsForward interest rates calculations 2

Forward interest rates paymentsForward interest rates settlementsForward interest rates prices

  • 45 minutes
  • 7 question multiple choice test
  • What forward interest rates are and how they are calculated
  • How forward rate agreements (FRAs) work
  • The terminology associated with FRAs
  • How FRAs settle
  • How FRAs are used for trading and hedging

Forward Interest Rates - the details

1. Forward interest rates

  • What they are and how they are calculated, example
  • Use of forward rates, forward starting loans, market expectations, valuations

2. Forward rate agreements

  • How a FRA works as a contract for difference
  • Simple examples where gains or losses occur
  • How gains and losses are triggered
  • How gains and losses are calculated, example
  • Discounted settlement and its purpose, example

3. Market conventions & hedging

  • Terminology
  • Interest periods, example
  • Dealer’s screen prices, example
  • Bid and offer, example
  • Selecting the right price
  • Hedging a forward loan
  • Libor outcomes, profits and losses

4. Libor mismatches

  • Using FRAs to hedge dealer’s Libor mismatches
  • Explanation of the risk
  • Swap example
  • Hedging, example

5. Summary

6. Test

Related Documents

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Forward rate agreements (FRAs) are contracts for difference. They are traded in the over-the-counter (bilateral or non-exchange) market. They allow the two parties involved to hedge or speculate on interest rates in the future. Perhaps the easiest way to understand a FRA is to break it down into a loan and deposit. Let's try.

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Interest rate caps are a string of options on forward starting Libor. The individual option is called a “caplet” with the combined sum of each caplet’s value giving the cap price or premium. Forward interest rates are calculated from the par yield curve. To help understand them a simple example helps. If you borrow money for six months and deposit it for three months there is a rate of interest that you need to receive on your deposit between month three and month six in order to give you sufficient cash to repay your initial borrowing with interest. This is the breakeven or forward rate:

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Non deliverable forward (NDF) What is a non deliverable forward? It is a forward foreign exchange contract but instead of there being physical delivery at maturity of the currency pair the counterparties settle the transaction by a single net payment in the convertible currency. This payment represents the profit or loss on the trade. NDFs are used when a currency is not freely convertible. That is where the authorities only permit the exchange of the domestic currency through the central bank at an official spot rate. The proceeds of which may then be taken out of the country. If an exporter invoices in a non-convertible currency the invoice amount will eventually need to be sold (normally for USD) through official channels. As a result of the fluctuation of the spot rate the exporter may receive more or less USD than expected and is therefore subject to currency risk. This risk can be hedged with a NDF. Let's look at an example: