What does Fraption mean?
The fraption is an option that gives an interest rate guarantee protection. It is an option on a forward rate agreement. The option holder gets a right to buy a forward rate agreement at a certain strike price during a predetermined amount of time.
Futures Knowledge Explains Fraption
You can use fraption as an investment strategy to ensure a steady cash flow from your portfolio. For example, suppose you have a portfolio of cash assets of $100,000 which is earning four percent interest and would like to guarantee this four percent annual minimum return on the portfolio for next three years. You may buy a fraption by paying a premium. If interest rates decrease over the course of the next three years to say three percent, you can exercise the option, receiving the difference between the two rates.