That index is commonly an interbank offered rate (-IBOR) of specific tenor in different currencies, for example LIBOR in USD, GBP, EURIBOR in EUR or STIBOR in SEK.
The nature of each product has a distinctive gamma (convexity) profile resulting in rational, no arbitrage, pricing adjustments.
[1] Interest rate swaps (IRSs) are often considered a series of FRAs but this view is technically incorrect due to differences in calculation methodologies in cash payments and this results in very small pricing differences.
Their nature as an IRD product creates only the effect of leverage and the ability to speculate, or hedge, interest rate risk exposure.
is the decimalised day count fraction over which the value start and end dates of the -IBOR rate extend.
For mark-to-market (MTM) purposes the net present value (PV) of an FRA can be determined by discounting the expected cash difference, for a forecast value
is the discount factor of the payment date upon which the cash for difference is physically settled, which, in modern pricing theory, will be dependent upon which discount curve to apply based on the credit support annex (CSA) of the derivative contract.
Many banks and large corporations will use FRAs to hedge future interest or exchange rate exposure.
In other words, a forward rate agreement (FRA) is a tailor-made, over-the-counter financial futures contract on short-term deposits.
A FRA transaction is a contract between two parties to exchange payments on a deposit, called the Notional amount, to be determined on the basis of a short-term interest rate, referred to as the Reference rate, over a predetermined time period at a future date.