agreement (FRA) is an over-the-counter derivative instrument that trades as part of the money markets. In essence, an FRA is a forward-starting loan, but with no exchange of principal, so the cash exchanged between the counterparties depend only on the differ- ence in interest rates. While the FRA market is truly global, much busi- ness is transacted in London. Trading in FRAs began in the early 1980s and the market now is large and liquid. According to the British Bank- ers Association, turnover in London exceeds $5 billion each day. In effect an FRA is a forward dated loan, transacted at a fixed rate, but with no exchange of principal-only the interest applicable on the notional amount between the rate agreed to when the contract is established and the actual rate prevailing at the time of settlement changes hands. For this rea- son, FRAs are off-balance sheet instruments. By trading today at an interest rate that is effective at some point in the future, FRAs enable banks and corporations to hedge forward interest rate exposure. Naturally, they are also used to speculate on the level of future interest rates.   FRA Basics An FRA is an agreement to borrow or lend a notional cash sum for a period of time lasting up to 12 months, starting at any point over the next 12 months, at an agreed rate of interest (the FRA rate). The "buyer" of a FRA is borrowing a notional sum of money while the "seller" is lending this cash sum. Note how this differs from all other money market instruments. In the cash market, the party buying a CD, Treasury bill, or bidding for bond in the repo market, is the lender of funds. In the FRA market, to "buy" is to "borrow." Of course, we use the term "notional" because with an FRA no borrowing or lending of cash actually takes place. The notional sum is simply the amount on which interest payment is calculated (i.e., a scale factor). Accordingly, when a FRA is traded, the buyer is borrowing (and the seller is lending) a specified notional sum at a fixed rate of interest for a specified period, the "loan" to commence at an agreed date in the future. The buyer is the notional borrower, and so if there is a rise in interest rates between the date that the FRA is traded and the date that the FRA comes into effect, she will be protected. If there is a fall in interest rates, the buyer must pay the difference between the rate at which the FRA was traded and the actual rate, as a percentage of the notional sum. The buyer may be using the FRA to hedge an actual exposure, that is an actual borrowing of money, or simply speculating on a rise in interest rates. The counterparty to the transaction, the seller of the FRA, is the notional lender of funds, and has fixed the rate for lending funds. If there is a fall in interest rates, the