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Forward Rate Agreement - Borrowers

Forward Rate Agreement for Borrowers

Forward Rate Agreements are agreements between the bank and borrower in which the bank agrees to lend the borrower at an agreed certain interest rate on a nominal principal at a time in the future.

At the same time the borrower agrees to pay the bank the Bank Bill Reference Rate (BBSW) on the same nominal principal. As borrower this allows you to lock in the rate of your borrowing rather than be at the mercy of the markets. No exchange of principal occurs, only the difference between prevailing market interest rates and the FRA agreed interest rate is exchanged.

The reverse can also be arranged.

FAQs about FRAs for Borrowers.


Forward Rate Agreement for Borrowers – FAQs


What is a Forward Rate Agreement (FRA)?

A FRA is an agreement between two parties who agree on a fixed rate of interest to be paid/received at a fixed date in the future. The interest exchange is based on a notional principal amount for a term of no greater than six months. FRAs are used to help companies manage their interest rate exposures.

Who would use a FRA?

FRAs can be used by borrowers who have a desire or need to alter their interest rate or cash flow profile to suite their particular needs. FRAs are used by borrowers looking to protect themselves from, or take advantage of, future interest rate movements.

Variable rate borrowers would use FRAs to alter their interest cost by converting from being a variable rate interest payer to a fixed rate interest payer in a market where variable interest rates are expected to rise. Fixed Rate borrowers could use a FRA to convert from fixed interest payer to variable floating interest payer in market where variable interest rates are expected to fall.

How does a FRA work?

A FRA is an agreement between you and the Bank to exchange the net difference between a fixed rate of interest and a floating rate of interest. This exchange is based on the notional amount you require for the term nominated. The net difference between the two interest rates is applied against the underlying borrowing.

For example, XYZ Corporation, who has borrowed on a variable interest rate basis, has formed the view that interest rates are likely to rise. XYZ elect to pay fixed for all or part of the remaining term of the borrowing using an FRA (or a series of FRAs, (see Interest Rate Swaps), while their underlying borrowing remains variable, but hedged.

How much does a FRA cost?

There are no fees or other direct costs associated with FRAs. The price of a FRA is simply the fixed rate of interest at which the FRA was agreed between yourself and the Bank. The FRA rate will depend on the term of the FRA, how far forward the agreement is set for and current market interest rates.

Over what period can I obtain a FRA?

A FRA can be arranged for one to six month terms and beginning up to 18 months from deal date.

What are the benefits of FRAs?

Their flexibility. FRAs can commence out of any working day for a one to a six month period. The notional amount of the FRA can equal the principal of your borrowings or can cover a percentage of your borrowings. You can transact an FRA as your business needs arise or as your views on interest rates change.

Is there a minimum transaction amount for a FRA?

Bank of Melbourne is happy to quote on FRAs of $1,000,000 face value or more.

Can a FRA be used to lock in an interest rate on future borrowings?

Yes. Clients are able to use FRAs to lock in a fixed interest rate on expected borrowing exposures. For example, XYZ Corporation has a facility due to roll in three months time for a further period of six months. Concerned that interest rates are rising, they want to secure fixed rate funding for that period. XYZ enters into a six month FRA today, commencing in three months time and maturing in nine months as the fixed rate payer.

What happens if the interest rate outlook changes after I have entered into the FRA?

If your view of interest rates changes at any time after you have entered into the FRA, you have two choices. You can terminate the FRA, in which case the Bank will calculate any residual value and either the Bank will pay you this amount or you will pay the amount to the Bank. The residual value will depend on current interest rates at the time of termination. Alternatively, you can enter into an equal but opposite FRA which cancels the original transaction, leaving a residual value to be paid on the commencement date of the new FRA.

What happens if I repay my loan early? Is the FRA cancelled?

No. As the FRA is separate transaction it remains in place. However, you may wish to terminate the FRA as explained above.

Are there any risks associated with a FRA?

Yes. By entering into a FRA you have expressed your view on interest rates. Should interest rate movements be different to your expectations the FRA may have the opposite effect to what you were trying to achieve with the transaction. You can however, reverse or terminate the FRA should this start to happen (remembering you may be required to pay the Bank the difference between market interest rates and the FRA rate for the term of the FRA).

What other information do I need to know?

If you decide that FRAs are appropriate for you, the Bank will require you to sign our standard terms and conditions. These documents are easy to read as they have been written in plain English. They summarise the terms and conditions under which you agree to deal with the Bank.

Entering into a Forward Rate Agreement will also involve credit decisions by the Bank in relation to the FRA. This aspect of the transaction will be discussed with you by your Financial Markets representative.

How do I arrange a FRA?

Simply phone your Financial Markets representative to discuss your needs.

Need more information?

If you have any questions or want more information, you can contact us online or call us toll free on 1300 665 616.