LIC enters bond FRA market to hedge interest rate risk
Why in the news
LIC started trading bond FRAs with over 10 major banks to protect its portfolio from interest rate moves.
Key facts
- Purpose: hedge rate volatility for non-par products that need stable long-term returns.
- Likely effect: higher demand for 30-year-plus government securities, though forward spreads may narrow and hurt smaller players.
- An FRA fixes a rate for a future period on a notional principal; the difference between the agreed and market rate is paid in cash on settlement.
- Banks and insurers use FRAs to manage the effect of rate moves on borrowing costs or investment returns.
FRA versus bond forward
| Aspect | FRA | Bond forward |
|---|---|---|
| Contract | Lock an interest rate on a notional amount | Buy or sell a given bond at a set price later |
| Settlement | Cash, on rate difference | Physical delivery of the bond |
| Underlying | Interest rates; no bond or loan changes hands | A specific government bond or security |
| Risk angle | Hedges rate swings without owning a bond; may need to source bonds at settlement | Delivery is guaranteed, so settlement risk is removed |
| Status in India | Allowed and widely used | Recently permitted by RBI and IRDAI |
Exam angle
- FRA settles in cash; bond forward ends in delivery.
- Entity involved: Life Insurance Corporation of India.
- Regulators that permitted bond forwards: RBI and IRDAI.