Forward Rate Agreement Reset
Forward rate agreement (FRA) reset is a term used in the financial industry to describe the process of adjusting the interest rate on a forward rate agreement. This adjustment is made to reflect changes in the prevailing market interest rates. For those unfamiliar with the term, a forward rate agreement is a contract that allows two parties to agree on a future interest rate for a specified period of time.
When a forward rate agreement is entered into, the buyer agrees to pay a fixed interest rate to the seller for a specific period of time. This fixed interest rate is known as the forward rate. The seller, in turn, agrees to pay the buyer a floating interest rate based on prevailing market rates at the time of settlement.
However, market interest rates can change between the time the FRA is entered into and the time of settlement. This can result in a situation where the agreed-upon forward rate is no longer reflective of the current market interest rate. When this happens, a reset is necessary to adjust the terms of the contract accordingly.
The reset process involves calculating the difference between the original forward rate and the new market rate at the time of reset. This difference is then applied to the notional amount of the FRA to arrive at a new fixed rate that reflects the current market conditions.
It is worth noting that the reset process can work in favor of either party. If market rates have moved in favor of the buyer, they may end up with a lower fixed rate than what was originally agreed upon. Conversely, if market rates have moved in favor of the seller, they may end up with a higher fixed rate than what was originally agreed upon.
The frequency of FRA resets can vary depending on the terms of the contract. Some FRAs are reset daily, while others may only be reset once every few months.
In conclusion, forward rate agreement reset is an important aspect of the financial industry that helps to ensure that contracts remain fair and reflective of prevailing market conditions. As a professional, it is important to understand and communicate the technicalities of finance in a way that is accessible to a wider audience.
