Legal Definitions - forward-rate agreement

A forward-rate agreement (FRA) is a contract that specifies the interest rate on an obligation on a future date. For example, a company may enter into an FRA to lock in a specific interest rate for a loan that it plans to take out in six months. This helps the company manage its risk by protecting it from potential interest rate increases.

• A company enters into an FRA to lock in a 5% interest rate for a $1 million loan that it plans to take out in six months. If interest rates increase to 6% in that time, the company will still only pay 5% on the loan.
• A bank enters into an FRA with a customer to protect itself from potential interest rate decreases. If interest rates fall below the agreed-upon rate, the customer will pay the bank the difference.

These examples illustrate how FRAs can be used to manage risk and protect against potential interest rate changes.