Forward Rate Agreements

If we consider managing foreign currency risk, a Forward Rate Agreement (FRA) is an over-the counter agreement between two parties to buy or sell particular amount of foreign currency at a predetermined rate at a predetermined point of time. Thus the delivery date and trade date are separated. It enables a company to control foreign currency risk, by enabling them to be certain about their receipts and payments.

The spot rate, which is the actual rate at which the transaction actually takes place, might be quite different from the rate at which the contract is exercised. In such a case even though, you are going to loose, you have to obey the contract, because it is an obligation. The difference between the spot rate and the forward price refer to as either forward premium or forward discount, depending on the situation.