FRA Payoff formula
If rate increases long party/end user receives payment:
- Underlying Rate at Expiration – Forward Contract Rate
- Notational Principal * Rate Difference * Days in Underlying Rate / 360
- Discount payment back using Underlying Rate at Expiration raised to (Days in Underlying Rate / 360)
This is one of the biggest, nastiest formula in CFA Level 1, so it helps to break it down.
- FRA Payoff Numerator = NP * (Underlying Rate at Expiration – Forward Contract Rate) * (Days in Rate / 360)
- FRA Payoff Denominator = 1 + [Underlying Rate at Expiration^(Days in Underlying Rate / 360)]
Maintaining at least four decimal points of accuracy is important if you have to calculate forward rate agreement payoff in an exam.