To begin with, FRAs and STIRs are both short-term derivatives, up to a year ahead and lock in interest rates.

 

FRAs are set through private contracts and they are customised in terms of time and amounts. STIRs are set through standardised contracts and traded only on an official exchange in line with the rules in force. For this reason STIRs are cheaper than FRAs but they may not fit exactly. On the other side, FRAs are more expensive, but they may well meet the specific needs and requirements of the counterparties.

 

They are easier to be managed in comparison to STIRs as they require just one deal to secure the FRA transaction, and, on its maturity, one cash flow will move from one party to the contract to the other. Instead, as for STIRs margin money has to be paid to, or received from, the futures clearing house.

 

Because STIRs are standardised, the market for buying and selling STIRs contracts may be not only more liquid than FRAs contracts but also more transparent in terms of fair market prices, as all transactions are made publicly by the clearing house, which also bears the counterparty’s risk of default.

 

On the other side, when using FRAs, the exposure to the counterparty’s potential of default is much higher. FRAs are more used in foreign exchange, where the extra cost is low and the need of precise amounts transferred on precise dates is high, whereas STIRs are commonly used by financial institutions which manage a lot of hedging transactions.