Future rate agreements (2)

In three months ,when Ms.Jones needs the funds ,she obtains a nine-month loan at the current market interest rate .If the market rate at the time of the loan is 7.8 percent ,the other party in the FRA (Brown) pays her the difference between the market rate and the rate in the FRA , that is ,0.3 percent or 30 basis points,for the specified $10000 loan for nine months .should the market rate have fallen to 7.25 percent,Ms.Jones would reimburse Mr.Brown the difference,that is,0.25 percent for the specified nine-month loan .Jones is thus hedged against any increase in the lending rate between now and the time of the actual undertaking of the loan .she is ,however ,locked out receiving any benefits associated with a fall in the loan rate.Of course ,if the market rate is the same as the contract rate,then no offsetting payments are made by either party and the contract terminates.In essence ,Jones has contracted with Brown to exchange a floating or uncertain rate for a fixed rate over a specific time period.Indeed ,An FRA is often defined as forward contract in which two parties agree to exchange a floating rate for a fixed rate for some future time period .LIBOR is commonly used as the floating rate in these agreements .