FRAs

[navman]

I have a definitional question for forward rate agreements.
eg if I go long a 5% 1 x 3 FRA (notoinal principle $1m) then in 1 month I will be borrowing this amount and paying 5% interest for 2 months.
What I don't understand is why by definition does the FRA "expire" or "mature" in 1 month??
I would have thought the FRA expires in 3 months (end of borrowing period) since this is when I stop paying borrowing costs?

 

[navman]

Trying to answer my own question, is it because at expiry the difference in value between the long and short position on a FRA is settled via a cash payment?

 

[Steely Dan]

navman wrote:
I have a definitional question for forward rate agreements.
eg if I go long a 5% 1 x 3 FRA (notoinal principle $1m) then in 1 month I will be borrowing this amount and paying 5% interest for 2 months.
What I don’t understand is why by definition does the FRA “expire” or “mature” in 1 month??
I would have thought the FRA expires in 3 months (end of borrowing period) since this is when I stop paying borrowing costs?
An FRA is an AGREEMENT. Think of this as being in the same category as a call or put - some sort of “agreement” to do something in the future.
The FRA expires at the point when the loan is initiated. So in a 1 x 3 FRA, in 30 days (the “1”) the loan is initiated for 60 days (the “3” minus the “1”). It’s during that 30 days, (the “1”) that interest rates can move up or down so by the time the FRA matures and the loan is to be initiated, the FRA can see a profit or loss. Does that make sense?

 

[navman]

Yes that makes sense. Many thanks for that