20 Sep Forward Rate Agreement Strike
A differential contract with cash payment at a short-term interest rate set at a future date. Unlike premium or advance points, outright prices are expressed in absolute price units. Outrights are used in markets where there is no spot price or reference rate (single) or where the spot price (interest rate) is not easily accessible. [12] Suppose Bob wants to buy a house in a year. Suppose at the same time that Andy currently owns a house worth $100,000 that he wants to sell in a year. Both parties could enter into a futures contract. Assuming they both match the selling price of $104,000 in a year (see more on why the selling price should be that amount). Andy and Bob have entered into a date contract. Bob, because he buys the underlying, would have entered into a long-term contract. Conversely, Andy will have the short forward contract. Therefore, if speculators maintain a net long position, the expected future spot price must be higher than the futures price. 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] Allaz and Vila (1993) suggest that there is also a strategic reason (in an imperfect competitive environment) for the existence of futures trading, i.e. that futures trading can also be used in a world without uncertainty. .