What do forward rates mean?

A forward rate is an interest rate applicable to a financial transaction that will take place in the future. The term may also refer to the rate fixed for a future financial obligation, such as the interest rate on a loan payment.

Are zero rates and spot rates the same?

1 The spot interest rate for a zero-coupon bond is calculated the same way as the YTM for a zero-coupon bond. The spot interest rate is not the same as the spot price. The method chosen depends on whether the investor wants to hold on to the bond or sell it on the open market.

Why are forward rates important?

Using the Forward Rate Regardless of which version is used, knowing the forward rate is helpful because it enables the investor to choose the investment option (buying one T-bill or two) that offers the highest probable profit. The actual calculation is rather complex.

How do you find forward rates?

To calculate the forward rate, multiply the spot rate by the ratio of interest rates and adjust for the time until expiration. So, the forward rate is equal to the spot rate x (1 + domestic interest rate) / (1 + foreign interest rate).

What is a zero rate curve?

A zero curve is a special type of yield curve that plots interest rates on zero-coupon bonds to different maturities dates. These curves enable to price arbitrary cash flows, fixed-income instruments, and derivatives.

How are spot rates and forward rates calculated?

Theoretically, the forward rate should be equal to the spot rate plus any earnings from the security (and any finance charges). You can see this principle in equity forward contracts, where the differences between forward and spot prices are based on dividends payable, less interest payable during the period.

How are forward rates used?

Forward rate is the theoretical yield on a bond that will occur in the future (in most cases, several months or years from the time of the calculation). Yield is a term referring to the return on the bond buyer’s investment. Generally, forward rate is used when discussing the purchase of T-bills, or Treasury bills.

Why are forward rates higher?

In bond markets, the price of an instrument depends on its yield—that is, the return on a bond buyer’s investment as a function of time. If an investor buys a bond that is nearer to maturity, the forward rate on the bond will be higher than the interest rate on its face.

What is the formula for forward rate?

How does a forward rate agreement work?

Forward Rate Agreements are agreements between the bank and borrower in which the bank agrees to lend the borrower at an agreed certain interest rate on a nominal principal at a time in the future. At the same time the borrower agrees to pay the bank the Bank Bill Reference Rate (BBSW) on the same nominal principal.