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Simple English definitions for legal terms
forward-rate agreement
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A quick definition of forward-rate agreement:
A forward-rate agreement is a contract that says what the interest rate will be on a future date. It's like making a promise about how much money you'll get for lending someone money in the future.A more thorough explanation:
A forward-rate agreement (FRA) is a contract that specifies the interest rate on an obligation on a future date. For example, a company may enter into an FRA to lock in a specific interest rate for a loan that it plans to take out in six months. This helps the company manage its risk by protecting it from potential interest rate increases.
- A company enters into an FRA to lock in a 5% interest rate for a $1 million loan that it plans to take out in six months. If interest rates increase to 6% in that time, the company will still only pay 5% on the loan.
- A bank enters into an FRA with a customer to protect itself from potential interest rate decreases. If interest rates fall below the agreed-upon rate, the customer will pay the bank the difference.
These examples illustrate how FRAs can be used to manage risk and protect against potential interest rate changes.