Public Sector Entities

Larger amounts of capital can be raised on the bond market at attractive rates for the issuers. Due to their low risk and fixed interest rates, bonds are highly popular with a broad investor base. Through the issuing of bonds, issuers have the opportunity to enter capital markets in a way that generates publicity.

In the case of private placements, debtor bonds are issued directly to a select group of large, mostly institutional domestic and foreign investors. For issuers, this represents a simple and cost-effective financing option on the capital market without trading on a public exchange. In addition, there is a high level of flexibility in structuring the borrowing. Private placements are particularly suitable as a financing instrument for borrowers with a lower capital need, as they are not subject to a minimum size, or as a supplementary financing instrument for bonds and bank loans.

A forward rate agreement (FRA) allows public sector entities or private institutions to already lock in the interest rate applicable to future investments or loans. In this process, the buyer and the seller of an FRA agree on a hypothetical money market transaction in the future.

The exact term (agreement period), amount, and interest rate of the agreement are also determined in advance. Upon maturity, i.e. on the specified start date of the hypothetical money market transaction, the agreed interest rate is compared with the market rate and the difference is offset between the partners. The traded capital is not exchanged; the agreement merely ensures a measure of protection for interest payments.

Under a forward rate agreement, fictitious time deposits are usually traded with terms of 3, 6, 9, or 12 months that are 1 to 24 months in the future. A credit limit and a framework agreement for derivative transactions are required to enter into an FRA.

Advantages

• The forward rate agreement provides a secure basis for calculation because it protects both parties against an unfavorable interest rate trend: the borrower (FRA buyer) against rising interest rates and the investor (FRA seller) against falling interest rates.
• Where funds are committed for the long term, the FRA provides a means to exploit market opportunities if interest rates develop favorably.
  
• As a bespoke over-the-counter product (OTC), the FRA is not subject to any fixed contract sizes or any obligation to impose a premium or margin, unlike stock market futures.
  

Disadvantage

• As the FRA is based on the interest rate differential, it does not provide a liquidity commitment. The company must raise the capital itself.