[CROSSTALK]
[NOISE]
Can you explain the difference between a
Forward, forward and a forward rate
agreement?
[SOUND]
A forward, forward and a forward rate
agreement, and a
FRA, and I suppose we could call a forward
also.
The whol,this whole lecture, where I'm
talking about, for,
forward rates and the expectations
hypothesis and all of that.
Okay.
The point of this lecture is to begin to
build
some intuition that we're going to use
later on about derivatives.
So, the for, forward interest parity.
Calling it forward
Interest Parity is
I write it, 1 plus R 0 N,
[SOUND]
times 1 plus F N T,
equals 1 plus R(0,
T).
Right?
Yes.
Okay, and the the point of this is to say,
this
is a, this is a an interest rate, this is
eh,
[UNKNOWN]
that you can observe today okay, between
time zero and time N.
This is an interest rate that you can
observe today between time zero and time
T.
Okay.
And the point of the, the deep point
behind all this, is that if
you can borrow and lend at this rate, and
borrow and lend at this rate.
Now, of course there's going to be a bit
as
spread in there, but this came before we
did
market making, so let's just abstract from
bit as spreads.
So let's just think that you can borrow or
lend at this rate.
>>
[COUGH]
>> And you could borrow or lend at this
rate.
The point is that you can construct, okay,
with
these fundamental assets a, a forward a
forward rate.
You can, you ca, can construct the ability
to
borrow at time N and pay back at time T.
Okay.
And the way you would do that is, if you
were a bank, okay, okay,
you want to, if you had borrowing 1 plus R
0 no, borrowing.
Put it on the other side.
1 plus R 0 T.
So if you're borrowing for at, at, at, for
this ti, this amount of time, and you're
lending for this amount of time, okay,
essentially what
you're doing is you're expanding your
balance sheet on
both sides today, you're neither borrowing
nor lending.
Nothing's happening.
Okay?
you understand this notation?
I'm saying this is, this is, this is a,
term, T borrowing, okay?
And this is term N lending.
[SOUND].
Yeah, sometimes I make up weird notation
that confuses people.
So, so let me just be clear what that is.
And so you're, eh, eh, at time zero,
you're neither borrowing nor lending.
Okay, but at time, N, okay, suddenly,
this, you, you get money.
Okay, that's what this, you know, this
thing, this thing matures.
Okay.
And at time, T, you have to pay money,
okay.
Well what is that?
You get money at time N, you pay it at
time T.
That's like borrowing it at time, at time
N, and paying back at time T.
So, you're creating a synthetic future
loan, basically.
By, by doing this long and short
positions.
>>
[COUGH]
>> Okay.
And that is essentially borrowing at this
rate.
Okay?
This is the rate, the forward rate is the
rate you can lock in today using these
existing instruments.
Okay, and that's what forward interest
parity says.
Forward interest parity says that if you
are trading, if you are just
trading with people in the forward market,
okay, this is the forward rate.
The forward rate has to be this.
It cannot be
anything other than this because you could
roll
your own forward rate, okay, in these
markets.
[SOUND]
Okay, that's the basic idea.
Then, I think
[UNKNOWN]
it was, it was you that asked this
question.
Okay, so now you, you asked these specific
questions about all these other things.
All these other things are in that
lecture.
[LAUGH]
To, to as, as examples, historical
examples
that are in, that are in, in stigham.
About how the banking system, created
different, it, it
doesn't want to have, it doesn't want to
use these synthetic structures.
Okay, because it takes up balance sheet
space.
You know, if you had, if your balance
sheet is expanding on both
sides and you're not lending or borrowing,
you're not making any money and
you have fixed capital and you have fixed
reserves, okay.
And it looks like you're, you know, you're
taking risk.
and, and liquidity risk and solvency risk
and
all of this and the regulators aren't
going to
like that, your board of governors aren't
going to
like that, no one's going to like that,
okay?
So, and, so the, the attempt is to create
instruments that have this effect that are
just a if they, you are borrowing and
lending but there is various levels of
netting out.
Okay, that are, that are happening and
the our forward agreement nets everything
out of, of, of but you actually you agree
to do this thing you know our forward
agreement says in three months,okay?
I will lend you so much money and at such,
such a rate, okay.
A FRA is just a, is just a side bet on
what, for rate agreement,
is a side bet on what the interest rate
will be three, three, months from now.
Okay, so it's a sort
of derivative contract.
and a forward, forward, forward, forward
was what?
forward, forward is, I think, I think this
was
[UNKNOWN]
forward, forward was in agreement was an
agreement,
to, I forgot what a forward, forward is.
>> When the net principal payments are
on the balance sheet, they're not zeroed
out.
>> Okay.
There, there, but the point is all the
three of these.
Are, are different versions of, of this,
where you're, where you're netting out
principal
payments or you're not, or you're netting
out the interest payments or you're not.
But the underlying,
the underlying conceptual basis of it is
all this.
All of them are the, are doing the same
thing.
In different, in different ways.
You can see all this very clearly.
This, the reason I go to this effort,
okay,
[LAUGH],
is that you can see all this very clearly
when you're dealing
with fixed income instruments and the
money market and all of this.
When you start to move into foreign
exchange, when you
start to move into credit default swaps,
we lose our intuition.
Okay, but, but it's the same intuition as
this.
So once we, if we really consolidate that,
we're going to be happier
after the midterm is the, is the idea, is
the idea here.