Context:
Life Insurance Corporation of India (LIC) has signed $1 billion worth of forward rate agreements (FRAs) with major Wall Street banks, marking a major push into bond derivatives.
Forward Rate Agreements (FRAs)
A Forward Rate Agreement (or FRA) is an agreement between two parties to exchange payments usually equal to short term underlying interest rate obligations of those two parties. The notional principal amount of a FRA is used to calculate the interest payment only and is not exchanged. FRAs allow LIC to lock in future bond yields, protecting income from falling interest rates.
Bond Derivatives
Bonds are fixed-income securities that reflect loans made to borrowers by investors. Derivatives can be understood as a security with a price that is based on or derived from one or more underlying assets is referred to as a derivative.
Market Impact
- LIC’s participation is boosting demand for long-term bonds.
- The last two auctions for long-term bonds saw record bid-to-cover ratios in FY26 (since April 1).
- Banks, in turn, hedge their exposure by buying long-term bonds, increasing overall bond market depth.
Working Mechanism of FRA
- In an FRA, LIC agrees to purchase a bond at a fixed future price.
- The bank counterparty assumes bond price risk and earns a premium.
- This instrument is vital for insurers to stabilize portfolio returns amid uncertain interest rate cycles.
Significance
- LIC’s aggressive FRA participation:
- Deepens India’s bond derivatives market
- Enhances risk management practices among institutional investors
- Aligns with global standards in insurance portfolio management
- Signals a shift toward modern financial instruments for liability-driven investment strategies in India.
