Forward interest rate agreements (FRA) are linked to short-term interest rate futures (STIR). Since STIR futures oppose the same index as a subset of FRAs, IMM FRAs, their pricing is linked. The nature of each product has a unique gamma profile (convexity), which leads to rational price adjustments, not arbitrage. This adjustment is called a term convexity adjustment (CFL) and is normally expressed in basis points. [1] In order to offset this advantage of investing in futures contracts over FRFs, a convexity adjustment is therefore made and, in the naïve sense of the term, subscribing to this pricing review for other articles on this topic FRA / Futures Convexity has nothing to do with the fact that gains/losses will be immediately recognised in the future by the margin statement, when transferring to the FRA. Futures contracts are valued daily with margins, so that if a trader receives a future and interest increases, money is deposited into his Margin account, and when rates fall, the money is deducted daily from his Margin account, so that we have two results from a single position: they end with the scenario where the interest rates on this portfolio rise, You need to buy more FRA to stay protected by delta. But you buy at higher prices. If the price drops again, sell it to stay secure delta, which will cost you money. It is therefore a process that depends entirely on volatility. Ndisplaystyle N} being the fictitious rate of the contract, R {displaystyle R} the fixed interest rate, r {displaystyle r} the published IBOR fixing rate and d {displaystyle d} the decimalized dawn on which the start and end dates of the IBOR rate extend. For USD and EUR, an ACT/360 convention follows and the GBP is followed by an ACT/365 convention. The cash amount is paid at the beginning of the value applicable to the interest rate index (depending on the currency in which the FRA is traded, either immediately after or within two working days of the published IBOR fixed rate). In other words, a term interest rate agreement (FRA) is a tailor-made, non-payment financial futures contract on short-term deposits.

An FRA transaction is a contract between two parties for the exchange of payments on a deposit, the so-called nominal amount, which must be determined on the basis of a short-term interest rate called the reference rate, over a period predetermined at a future date. Fra transactions are recorded as hedges against changes in interest rates. The buyer of the contract blocks the interest rate to guard against a rise in interest rates, while the seller protects against a possible fall in interest rates. At maturity, no money exchanges hands; on the contrary, the difference between the contractual interest rate and the market price is exchanged. The buyer of the contract is paid if the published reference rate is higher than the contractually agreed fixed rate and the buyer pays to the seller if the published reference rate is lower than the contractually agreed fixed rate. A company that wants to hedge against a possible rise in interest rates would buy FRAs, while a company that seeks to hedge interest rates against a possible drop in interest rates would sell FRAs. This is a good explanation up to the last two paragraphs. You should say: “To compensate for this advantage of SHORTING futures contracts over the FRA… ».

And then the equation is $$FRA rate = Futuresspace Impliedspace Rate – Convexityspace Adjustment$$$3) Suppose the future is closed every day at the same price, so that no profit exchange was ever made (but it was a coincidence). . . .