Let's take a closer look at the two counterparties in a forward rate agreement. Unusually for the OTC interest rate world, the terms buyer and seller are used in FRAs, and it's important to understand what those roles mean because they're not tied to any exchange of principle and they don't follow the logic of a typical bond transaction.

Here's the key point, the FRA buyer benefits if the relevant fixing of the underlying market rate ends up above the FRA rate. The seller, on the other hand, benefits if the fixing ends up below the FRA rate.

In other words, the buyer receives a positive payoff when rates go up, while the seller benefits when rates go down. So when you buy an FRA, you're effectively taking a short position in interest rate risk in the same way that on an interest rate swap, the payer swap gains when rates rise.

And as this cashflow diagram shows, an FRA can be viewed as a transaction similar to an interest rate swap, but for a single interest rate period. The FRA buyer agrees to pay the agreed FRA rate while the FRA seller pays the relevant fixing of the underlying market rate in return. In practice though, there's only ever one payment, a single cash flow on the settlement date. Based on the net difference between the FRA rate and the actual fixing. That payment will flow to either the buyer or the seller, depending on the direction of the rate move.