21 février 2022
Forward Rate Agreement Delta
Posted by under: Non classé .
As a copy editor, it is important to understand and write about different financial terms and instruments that are used in the world of finance. One such instrument is the Forward Rate Agreement (FRA), which is used by financial institutions to manage interest rate risks. This article will focus on a specific aspect of FRA – the FRA delta.
What is a Forward Rate Agreement (FRA)?
A Forward Rate Agreement (FRA) is a financial contract between two parties; one party agrees to pay a fixed interest rate on a notional amount for a specified period in the future, and the other party agrees to pay the floating interest rate prevailing at that time for the same notional amount and period. The interest rate differential between the fixed rate and the floating rate is settled in cash at the end of the contract.
What is FRA Delta?
The FRA delta is a measure of the sensitivity of the FRA price to changes in the underlying interest rate. It represents the change in the FRA price for a small change in the underlying interest rate. The delta is usually expressed in basis points (bps), that is, one-hundredth of a percent. A positive delta indicates that the FRA price would increase with a rise in interest rates, while a negative delta indicates that the FRA price would decrease with a rise in interest rates.
How is FRA Delta Calculated?
FRA delta is calculated using the following formula:
Delta = (P1 – P2) / (R1 – R2)
Where,
P1 = Price of the FRA when the underlying interest rate is R1
P2 = Price of the FRA when the underlying interest rate is R2
The FRA price is calculated using the following formula:
FRA price = (R2 – F) x D / (1 + R1D)
Where,
F = Fixed rate agreed in the FRA contract
R2 = Expected floating rate prevailing at the end of the FRA period
R1 = Spot rate prevailing at the time of entering into the FRA contract
D = FRA period in years
Example:
Suppose a bank enters into a 3-month FRA contract with a notional amount of $1 million. The fixed rate agreed upon is 5%, and the spot rate prevailing at the time of entering into the contract is 4%. The expected floating rate prevailing at the end of the contract period is 5.5%.
Using the FRA price formula, the FRA price would be calculated as:
FRA price = (5.5% – 5%) x (3/12) / (1 + 4% x 3/12) = $4,166.67
Now, suppose the expected floating rate at the end of the contract period increases to 6%. Using the same formula, the new FRA price would be:
FRA price = (6% – 5%) x (3/12) / (1 + 4% x 3/12) = $5,000
Therefore, the FRA delta would be calculated as:
Delta = ($5,000 – $4,166.67) / (6% – 5.5%) = $16,666.67
This means that for every basis point increase in the expected floating rate, the FRA price would increase by $16.67.
Conclusion:
The FRA delta is an important measure for financial institutions that use FRAs to manage their interest rate risks. It helps them to assess the impact of changes in interest rates on FRA prices and to adjust their positions accordingly. As a copy editor, it is important to have a good understanding of financial terms and instruments, including the FRA delta, to write accurate and informative articles that cater to the needs of readers in the financial industry.
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