- Forward rate agreements (FRAs) are cash-settled contracts where parties agree on an interest rate to be paid in the future on a notional principal amount. - FRAs are settled based on the difference between the agreed FRA rate and the actual reference rate (typically LIBOR) at settlement, with the party owing paying the other. - Futures contracts are agreements to buy or sell an asset at a predetermined price and date in the future. They are standardized and exchange-traded, with continuous quotations. Settlement can be by physical delivery of the asset or cash.

1. FORWARD INTEREST
RATES,
FRAs and,
Intro. to FUTURES

2. Forward-Forward Contract
■ A customized contract between two parties that
guarantees a certain interest rateon
an investment or a loan for a specified time interval
in the future,
i.e. begins on one forward date and ends later.

3. Notion
■ Forward-forwards have a special notation to
designate the future term.
For instance, a term that begins in 6 months
and ends 1 year later, would be designated as 6
v 18.

4. How is the Forward Rate Determined?
■ The interest rate for the shorter period is the market yield with
the term equal to the number of days from the agreement date
until the contract begins.
The longer period is determined using the market yield with the
term equal to the number of days from the agreement date until
the contract ends.

5. FORWARD
RATE
AGREEMENT
FRAs
(Introduction)
NAWAL MERAJ

6. Defining the FORWARDRATEAGREEMENT
■ Similar to forward contracts
■ Two parties involved
BORROWER (Long) LENDER(Short)

7. EXAMPLE
Two parties can enter into an agreement to
borrow $1 million after 60 days for a period of 90
days, at say 5%.

8. CHARACTERISTICSOFFRAs
■ Usually cash-settled
■ Net amount is settled (difference between the current LIBOR and
the agreed FRA rate)
■ Payment made only at maturity
■ How a Long Position will Benefit?
■ How a Short Position will benefit?
■ Deposit amount is known as NotionalAmount
■ Determined on Short-term Interest rates (Reference Rates)

9. MECHANISM OF AN FRA AGREEMENT
■ A bank and a company are agreeing to the company being able to
borrow Rs. 50 million for six months in two months’ (2v8) time at
6.4167% interest.Current IR is 6%.
■ Effects, if Interest Rates Move up from 6% to 8% in two months?
■ Effects, if Interest Rates Move down to from 6% to 5% in two months?

10. FORWARD
RATE
AGREEMENT
FRAs
(Settlements)
SEHRISHGHAFOOR

11. FRA SETTLEMENTS
 The settlement on an FRA is settled net rather thangross.
 The difference is paid or received at the beginning ofthe
forward period to which it related.

12. FOR EXAMPLE
In a 2v5 FRA agreement, the difference is paid after 2months,
that is the beginning of the forward period.

13.  The buyer of the FRA pays the seller if LIBOR is fixed
lower than the FRA rate.
 The seller pays the buyer if LIBOR is fixed higher thanthe
FRA rate.

14. The formula for the settlement amount is:

15. EXAMPLE # 01
Consider a 3v6 FRA on a notional principal amount of $1 million.The FRA rate is 6%
. The FRA settlement date is after 3 months (90 days) and settlement is based
on a 90 day LIBOR. Assume that on the settlement date, the actual 90 day
LIBOR is 8%. Calculate the FRA settlement amount.

16. EXAMPLE # 02
Consider a 2v4 FRA on a notional principal amount of $1 million.The FRA rate is 6%
. The FRA settlement date is after 2 months (60 days) and settlement is based on
a 60 day LIBOR. Assume that on the settlement date, the actual 60 day LIBOR is
5%. Calculate the FRA settlement amount.

17. FRAPERIODS LONGER THAN 1YEAR
If the period of the FRA is longer than 1 year, the corresponding
LIBOR rates is used for settlement relates to a period where interest
is conventionally paid at the end of each year as well as at maturity.

18. FOR EXAMPLE:
■ A 6v24 FRA covers a period from 6 months to 24 months and will
be settled against an 18 month LIBOR rate at the beginning of the
FRA period.
■ An 18 month deposit would, typically pay interest at the end of one
year and again after 18 months.

19. FORMULA FOR PERIOD LONGERTHAN AYEAR BUT LESS
THAN 2YEARS

20. FUTURES
CONTRACT
MARIJ ZAFAR

21. DEFINTION
• A contractual agreement, generally made on the trading floor of a futures
exchange to buy or sell a particular commodity or financial instrument at a
pre-determined price in the future.
• Futures contracts detail the quality and quantity of the underlying asset.
• They are standardized to facilitate trading on a futures exchange.
• Some futures contracts may call for physical delivery of the asset.
• While others are settled in cash.

22. INTRODUCTION
■ The future contract is traded on a particular exchange.
■ Future contracts are generally standardized.
■ The specifications of each future contracts are laid down precisely by the
relevant exchange
■ vary from instrument to instrument and exchange to exchange.

23. ■ The theory underlying the pricing of a future contract depends on
the underlying instrument on which the contract is based.
■ For a future contract based on 3-month interest rates, the pricing
is therefore based on the same forward-forward pricing theory.

24. Example
3-month EURIBOR futures contract traded on LIFFE.
Exchanges: LIFFE (London International Financial Futures and OptionsExchange)
Underlying: The basis of the contract is a 3-month deposit of EUR 1 million based on
ACT/360 year.
Delivery: It is not permitted for this contract to be delivered: if a trader buys such a contract,
he cannot insist that, on the future delivery date, his counterparty makes an arrangement
for him to have a deposit for 3-months from then onwards at the interest rate agreed.
Delivery months: The nearest 3-months following the dealing and March, June,
September and December thereafter.
Delivery Day: First business day after the lastTradingday.
LastTrading Day: 10.00 a.m. 2 Business Days prior to the thirdWednesday of the delivery
month.

25. Settlement Prices: On the last day of trading- usually the third Monday of the month-LIFFFE
declares an exchange delivery settlement price (EDSP) which is the closing price at which
any contracts still outstanding will be automaticallyreversed.
Price: The price is determined as a free market and is quoted as an index rather than as
an interest rate.The index is expressed as 100 minus the implied interest.Thus a priceof
94.52 implies an interest rate of 5.48% (100 - 94.52 = 5.42).
Price Movement: Prices are quoted in unit of 0.005.This minimum movementis
called theTrek.
Profit and Loss value: The P&L is defined as being calculated on exactly 3/12 of a year
regardless of a number of days in a calendar quarter.The profit or loss on a single
contract is therefore:
Contract amount x price movement x 3/12
Therefore the value of a one basis point movement is EUR 25.00 and the value of a one tick
movement (The tick value) is EUR 12.50.
EUR 1 million x 0.01% x 3/12 = EUR 25.00
EUR 1 million x 0.005% x 3/12 = EUR12.50

26. There are relatively minor differences between future exchanges and even
between different STIR contracts on the same exchange.
■ Underlying: The typical contract specification for short term interest rate
futures is for 3-month interest rate. Although 1-month contracts also exist in
some currencies on some exchanges.
■ Delivery Date: STIR contracts worldwide are generally based on the delivery
month cycle of March, June, September andDecember.
■ Trading: Trading times vary. Some contracts are traded by open outcry,
notably on the IMM (the International Monetary Market, the financial sector
of the Chicago Mercantile Exchange (CME)) and some are traded
electronically.

27. ■ Price movement: Tick sizes andTick values, vary. For example, the
minimum price moment on Sterling is 1 basis point.The minimum price
movement for US dollars varies from ¼ basis point for the nearest dated
futures contract, through ½ basis points for the subsequent ones, to 1 basis
point for later ones.
■ Settlement price: The settlement price varies according to both currency
and exchange.

28. Example
A dealer expects interest rates to fall (future to rise) and takes a speculative
position. He therefore buys 20 EUR 1-month futures contracts at 95.27. He
closes them out subsequently at 95.20.What is hisprofit?
The price has fallen, so he makes a loss of EUR3,500:
Number of contracts x contract amount x price movement x 1/12
= 20 x EUR 3,000,000 x 0.07% x 1/12 = EUR 3,500

29. SHORT-TERMINTERESTRATEFUTURES
Price= 100 – (implied forward-forward interest rate x 100)
Profit on a long position in a 3-month contract
= contract amount x (sale price – purchase price)/100 x 3/12

30. THE
MECHANICS
OF
FUTURES
SHARJEEL MERAJ

31. THEMECHANICS OF FUTURE
MARKETPARTICIPATION:
 Members
 Customers
 Locals
 PublicOrder Member

32. OPEN OUTCRY VERSUS SCREN-TRADING
OPENOUTCRY:
The buyer and seller deal face to face in public in the exchange’s trading pit.
SCREENTRADING:
Designed to simulate open outcry but with the advantage of lower costs and
wider access.

33. CLEARING:
 The futures exchange is responsible for administering the
market, but all transactions are cleared through a clearing
house.
 Only clearing members of an exchange are entitled to clear
their transactions directly with the clearing house.
 Non-clearing members have to clear all their transactions
through a clearing member.

34. MARGIN REQUIREMENTS
 Initial Margin
 Variation Margin

35. CALCULATION OF VARIATION MARGIN
The variation margin required is the tick value multiplied by the number
of ticks price movement since the close the previous day.
EXAMPLE:
If the tick value is EUR 12.50 on each contract, and the price moves from
94.370 to 94.215 ( a fall of 103 ticks), the loss on a long future contract
is EUR (1.250 x 103) = EUR 1287.50

36. CLOSINGOUT:
A futures position can be closed out by means of anexactly
offsetting transactions.
LIMIT UP/ DOWN:
Some markets impose limits on trading movements in an attempt
to prevent wild price fluctuations and hence limit risk to some
extent.

37. BASIS
Basis is the difference between what the futures price would
be based on the current cash interest rate, and the actual
futures price.

38. Value basis = Theoretical futures price – Actual futuresprice
Basis = Implied cash price – Actual futures price
Basis Risk is the risk arising from the basis.

39. EXAMPLE:
It is now mid-February and the current 3-month GBP LIBORis
5.32%; the current June futures price is 94.37 and the
theoretical June futures price based on the current cash
market is 94.30.