In a Forward Rate Agreement (FRA), the buyer (or the 'long') locks in a borrowing rate, while the seller (or the 'short') locks in a lending rate. If the spot rate at the time of the transaction is higher than the forward rate, the buyer will benefit. This is because the buyer will receive payments at a lower rate than the prevailing market rate. On the other hand, the seller will be worse off because they will be lending at a lower rate than the current market rate. This scenario is advantageous for the buyer because they have effectively hedged against the risk of rising interest rates. Conversely, the seller, who may have anticipated a fall in interest rates, will be at a disadvantage as they are locked into lending at a lower rate.

Choice A is incorrect. This statement is not accurate because if the spot rate surpasses the forward rate, it does not mean that both the buyer and seller will be worse off. The buyer, who has secured a lower borrowing rate through the FRA, will benefit as they will pay less than the prevailing market rate. On the other hand, the seller who has agreed to lend at a predetermined lower rate will be worse off as they could have lent at a higher spot rate in absence of this agreement.

Choice B is incorrect. This choice incorrectly suggests that if spot rates surpass forward rates, then sellers would benefit by lending at a lower rate. In reality, sellers would be worse off because they are lending money at a lower interest than what could have been achieved in open market.

Choice D is incorrect. It's not true that both parties remain unaffected when spot rates exceed forward rates in an FRA contract. The buyer benefits from paying less interest while seller incurs loss due to receiving lesser interest than what could have been earned on open market.

Things to Remember

• Forward Rate Agreements (FRAs) are over-the-counter contracts that allow parties to