Forward Rate Agreement

What is a forward contract / what does it allow you to do?

A forward contract allows you to buy/sell something at a predetermined price on a future date.

What is the difference between fixed income and equity markets?

Fixed income securities have maturities.

What is the 6X12 interest rate?

It is the corresponding forward rate that we promised on the future loan.

Describe a 6X12 forward contract?

It starts in 6 months and last for 6 months.

What is this pre-determined price called?

The forward price

What is the interest component to the forward price?

The interest component to the forward price is the cost of carrying the product from now until we accept delivery of the underlying product.

Essentially, when entering a forward contract, what are we asking the counter party to do?

We ask the counter party to buy the underlying product at the spot price and then carry it through to the agreed point in time when we would pay for and accept delivery of the product.

What are important features of a forward contract?

-No payment at t=0 from either party -No actual loan..only the difference is settled

Counter parties to a forward contract agreement agree on what terms?

-The future interest rate -When the loan starts -How long the loan will last -The amount of the loan

Does the counter party take risk?

No, the counter party takes no risk at all. Since he/she already buys the share from time=0, regardless of the volatility in shares, he/she will always be able to deliver the share.