Financial Management

What is a Forward Rate Agreement and How Does It Work?

Two parties can agree to predetermine an interest rate obligation for a future payment. The agreement is made on the forward rate, hence the name Forward Rate Agreement (FRA). FRAs are over-the-counter instruments that can be arranged by two parties directly. FRAs can be used in interest rate hedging planning. FRAs are particularly useful in …

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What is an Interest Rate Collar? How Does an Interest Rate Cap Work?

Interest collars limit the losses due to an adverse movement in interest rate for an underlying asset such as a bond. Collars also restrict the maximum gains due to favorable interest rate movements, though. Interest rate caps are upper limits of an interest rate options contract. In contrast, floors are the minimum interest rate limits …

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What are SWAPs Contracts and Different Types of SWAPS?

A Swap is a financial derivative that allows two parties to exchange liabilities or revenue streams from two underlying assets with opposing characteristics. Usually, Swaps involve a fixed cash flow stream and a variable cash stream. Swaps are over-the-counter derivates that are arranged directly by two parties. These instruments do not trade like other marketable …

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Theoretical Ex-Rights Price – TERP: What Is It and How to Calculate?

Theoretical Ex-Rights Price or TERP is the price of the shares immediately after the rights issue. A rights issue is the offering of shares to existing shareholders. As companies issue new shares, it dilutes the company’s shareholding. Thus, its share prices get affected due to rights issues. Since rights attached to existing shares have value, …

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Futures Contracts: Definition and How It Works

Futures contracts or simply Futures are derivatives as they derive their prices from an underlying asset. Futures are traded in standardized forms and are regulated by the Commodity Futures Trading Commission (CFTC). Futures can be used for hedging and speculation. Once agreed, Futures become an obligation to exercise the contract on the expiration date. However, …

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Dual Currency Bonds: Definition, How It Works and More

A bond issued in one currency and paying coupon payments in another is termed a dual currency bond. Investors and issuers can agree on the terms and conditions, including fixing the conversion rate, maturity, and interest rate at the time of issuing the bond. Dual currency bonds are lucrative fixed-income instruments for foreign investors. However, …

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Portfolio Immunization Strategy: What Is It and How Does It Work?

Portfolio immunization is a strategy that matches the duration of assets and liabilities to mitigate interest rate risks. Investors and businesses can use the immunization technique with different options to safeguard their net assets against interest rate risks. Portfolio immunization works well with fixed-income instruments such as bonds. That’s one reason portfolio managers prefer using …

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Asset-Backed Security: What Is It and How Does It Work?

For investment instruments, asset backing means a security instrument whose value derives from a pool of assets. These assets are used as collateral or backing for the newly created security. Thus, asset-backed security (ABS) refers to a security that is backed by a pool of financial assets such as different types of loans. Asset-backed securities …

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