A company wants to borrow £5.6m in three months’ time for a period of six months. The current interest rate is 6 per cent and the company, fearing that in three months’ time the interest rate may have increased, decides to hedge using a forward rate agreement (FRA). The bank guarantees the company a rate of 6.5 per cent on a notional £5.6m for six months starting in three months’ time (known as a 3 v 9 FRA). If interest rates have increased after three months to say 7.5 per cent, the company will pay 7.5 per cent interest on its £5.6m loan, which is 1 per cent more than the rate agreed in the FRA. The bank will make a compensating payment of £28,000( 1percent × £5.6m × 6/12 to the company, covering the higher cost of its borrowing. If interest rates have decreased after three months to say 5 per cent (1.5 per cent below the agreed rate), the company will have to make a £42,000 payment (1.5 per cent ×  £5.6m × 6/12) to the bank.