Forward Rate Formula and Definition

Before you take a look at the forward rate formula, you need to know the definition of forwards rate to understand it more. A forward rate is a financial transaction rate applicable taking place in the near future. It is based on spot rates that are adjusted for carrying cost as well as it refers to rates that calculate forward rate that used in delivering a bond, a commodity or a currency in the future. Continue reading for more useful info and economics homework answers here.

forward rate definition

Short History about Forward Rate

Forward rate can be referred to as a rate fixed like interest rate on loan payment. In FOREX, it means that forward rates are specified in the agreement is called as a contractual obligation, wherein it should be honoured by all parties being involved.

General Information about Forward Rate

When it comes to the bonds context, the forward rates are being calculated in determining the future values. So if an investor purchases a 1-year bill treasury or a 6-month bill, you should roll it to another 6-month bill by the time it matures. Another thing is that the investor will be concerned, especially if they produce same results. He knows that the sports rate for a 6-month bill as well as 1-year bond, but he knows the 6-month bill value that is being purchased 6 months from now. In these 2 rates, the forward rates on a 6-month bill are the rate that equalizes the dollar return of the two investment types mentioned earlier.

Forward rate is used in currency and bond trading in expressing the expectation o the future value of the bond or currency. In bond trading, the forward rate is the implied rate that is calculated from the current interest rates on different bond maturities.

forward rate formula and definition

How to Calculate Forward Rate

Knowing how to calculate forward rate is essential so that you will know how to answer your homework. You need to know the right formula to avoid mistakes and in calculating forward rates from the spot rates, here it is,

ft-1, 1=(1+st)t ÷ (1+st-1)t-1 -1

Where:

st: Will be the t-period spot rate

ft-1,t: Will be the forward rate applicable for the period (t-1,t)

If the one-year spot rate is 11.67% and the two-year spot rate is 12%, then the forward rate applicable for the period one year up to two years will be:

f1, 2 = (1+12%)2÷ (1+11.67%)1 -1 = 12.33%

forward rate formula

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