Forward Misses Agreement - SpeedyLook encyclopedia

A Forward Misses Agreement , or FRA , is a product Dérivé used on the Money market.

It is about a Contrat Forward, negotiated Private between two counterparts and whose objective is the fixing as of today of a Taux in fine of reference, calculated and published by a third party, which will be known only on one future date.

Elements of the contract

The components of the FRA are thus:

MN its par value;
the nature of the reference rate TR : generally it is about a IBOR ( Inter-Bank Offered Rate is, in French: interbank rate offered) like the Euribor or LIBOR of a specified currency;
the rate in fine T with which the two parts treated, i.e. the rate of the FRA;
the start date DD of at which time the reference rate applies;
the completion date DF of the aforesaid the period;
the date of exchange of financial flow, or date of payment DP :

DP = DD + 2 working days seems to be the convention universally applied in the world; LIBOR and Euribor, indeed, are rates for departure Spot, i.e. two working days after the date of calculation;

and finally NJA the being useful number of days of the year as calculation bases according to the uses of the money market of the currency in which is made out the FRA. In Continental Europe and in the United States, one carries out calculations with NJA = 360 days, while in Great Britain and in the Commonwealth Countries one generally uses NJA = 365 days.

${} Payment = MN \ left (\ frac {(TR-T). (DF-DD) /NJA} {1+ TR. (DF-DD) /NJA} \ right)$

N.B. : the denominator 1 + TR. (DF-DD) /NJA is made necessary by the fact that it is here about rate in fine, i.e. for payment of the interests at the end of the period. However the payment of the FRA takes place at the beginning of the base period…

Conventions of transaction

By convention, the purchasing of the FRA is that of the two counterparts which begins to pay the rate T that they negotiated and to receive the reference rate not yet known TR .

That is on the other hand with the prevalent use on the markets of Interest rate where the purchaser of a product is normally that which will profit from a fall of the rates in the future.

Conventions of notation

The FRA are generally noted has X' B' , with B>A , meaning:

the base period starts in 2 working days + has month ;
it lasts B - has month.

As follows:

2 X' 6 indicates 4 mois' beginning in 2 months and 2 working days;
1 X' 3 indicates 2 mois' beginning in one month and 2 working days;
12 X' 24 will indicate a an' beginning in one year and 2 working days.

Differences between future FRA and bearing on the same reference rate and the same dates

The more distant their expiry is in time, and the more different the contracts in the long term on IBOR 3 months are from the FRA which they are supposed to however retort. Indeed, unlike the contracts in the long term, whose variations of rate in fine give place to the payment immediate and linear of the price difference, via the call for additional cover, the FRA can cause only profits or losses in the future, that it is thus advisable to bring up to date, and whose current value, nonlinear, thus has a convexity higher than that of future.

That implies that if the two instruments had the same rate in fine, it would exist an arbitration without risk to buy in great quantity a FRA moved away, to sell the future corresponding and to adjust the position in risk of rate each day while thus benefitting from the volatility of the market. In order to neutralize this phenomenon, the future ones must thus have a rate higher than that of the FRA , and this in an increasing way with the distance in time.

The difference in rate between the two instruments is called in English convexity bias , that is to say thus: correction to be brought taking into account different convexities. It is unfortunately not calculable directly and raises of assumptions on the future volatility of short-term interest rates.

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