Advantages And Disadvantages Of Fras

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The principle uses of Forward Rate Agreement or FRAs are contracts that can be structured to meet the specific needs of the user, counterparty exposure is limited to the interest rate differential between the market rate and the contract rate, administration costs are minimized as there is only one cash flow on the settlement date as opposed to daily futures settlement, they are off-balance sheet items, they can easily be reversed or closed out using an offsetting FRA at a new price. By entering into an FRA, the parties lock in an interest rate for a stated period of time starting on a future settlement date, based on a specified notional principal amount. A Forward Rate Agreement is an agreement between two parties who want to protect themselves…show more content…
• Unlike to interest rate options (for the buyer option) FRAs are binding agreements that must be settled at the settlement date.
• FRAs are normally more expensive than comparable interest rate futures contracts: futures might therefore be preferred when tailor-made agreements are not necessary.
• Once purchased, it does not have a market value and cannot be
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We sell the call and buy the put which gives us a per option cash flow today of $1.75 - $1.26 = $0.49. No matter what happens we'll buy 100 (because an option contract is for 100 options) shares for $34 each. Thus, a put option purchase won't benefit as much as a short forward position when prices decline (a put option has a delta > -1.) Thus, by using options we won't get any different forward price than if we traded silver futures. But we are paid $0.49 to do so which makes the price at which we are selling shares one week forward $34.39. Shares closed at $34.38 which shows the option prices are set by the forward silver price through arbitrage (the forward price is in turn set by the spot price and the time value of money). For example, to create a synthetic short forward position, you sell a call option and buy a put option with the same strike price. One can buy a put option to benefit from declining prices, but in so doing one is also placing a bet on increasing volatility. Of course, the bid/ask and transaction costs can make your return slightly different than selling futures. Regardless of the reasoning you can easily get around the restriction by creating a synthetic short forward position. (,
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