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Hi Sir,
I was wondering what is the difference between forward rate agreement and interest rate option?
In forward rate Eg if we need a loan of x amount and the X % but the actual is something else the bank would either pay us or we would have to pay them depending on if the rate is higher or lower right? But isn’t interest rate option pretty my the same?
As in there is a cap set and we only pay the lower rate Eg if rates when up we would pay our agreed rate and if the rate went down we would pay the market rate I guess ..?Sorry I’m a bit confused here as they seem exactly the same thing
Would you please be able explain
Thank you
An FRA effectively fixes the interest rate. If rates go up then you don’t pay more and if rates go down you do not pay less.
An interest rate option limits the maximum interest payable. If actual interest rates are lower then the option is not exercised and you get the benefit of the lower rate.
(The above is all from the point of view of someone borrowing money as opposed to someone depositing money.)
All of this is explained in detail in my free lectures. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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