Forward Rate

AAA

DEFINITION of 'Forward Rate'

A rate applicable to a financial transaction that will take place in the future. Forward rates are based on the spot rate, adjusted for the cost of carry and refer to the rate that will be used to deliver a currency, bond or commodity at some future time. It may also refer to the rate fixed for a future financial obligation, such as the interest rate on a loan payment.

INVESTOPEDIA EXPLAINS 'Forward Rate'

In forex, the forward rate specified in an agreement is a contractual obligation that must be honored by the parties involved. For example, consider an American exporter with a large export order pending for Europe, and undertakes to sell 10 million euros in exchange for dollars at a rate of 1.35 euros per U.S. dollar in six months' time. The exporter is obligated to deliver 10 million euros at the specified rate on the specified date, regardless of the status of the export order or the exchange rate prevailing in the spot market at that time. Forward rates are widely used for hedging purposes in the currency markets, since currency forwards can be tailored for specific requirements, unlike futures, which have fixed contract sizes and expiry dates and therefore cannot be customized.

In the context of bonds, forward rates are calculated to determine future values. For example, an investor can purchase a one-year Treasury bill or buy a six-month bill and roll it into another six-month bill once it matures. The investor will be indifferent if they both produce the same result. The investor will know the spot rate for the six-month bill and the one-year bond, but he or she will not know the value of a six-month bill that is purchased six months from now. Given these two rates though, the forward rate on a six-month bill will be the rate that equalizes the dollar return between the two types of investments mentioned earlier.

RELATED TERMS
  1. Convexity Adjustment

    The change required to be made to a forward interest rate or ...
  2. Range Forward Contract

    A zero-cost currency forward contract that uses a range of exchange ...
  3. Implied Rate

    An interest rate that is determined by the difference between ...
  4. Commodity

    1. A basic good used in commerce that is interchangeable with ...
  5. Forward Rate Agreement - FRA

    An over-the-counter contract between parties that determines ...
  6. Futures Contract

    A contractual agreement, generally made on the trading floor ...
Related Articles
  1. Interpreting Volume For The Futures ...
    Options & Futures

    Interpreting Volume For The Futures ...

  2. Options On Futures: A World Of Potential ...
    Options & Futures

    Options On Futures: A World Of Potential ...

  3. Futures Fundamentals
    Insurance

    Futures Fundamentals

  4. What are the advantages of commodities ...
    Retirement

    What are the advantages of commodities ...

comments powered by Disqus
Hot Definitions
  1. Halloween Massacre

    Canada's decision to tax all income trusts domiciled in Canada. In October 2006, Canada's minister of finance, Jim Flaherty, ...
  2. Zombies

    Companies that continue to operate even though they are insolvent or near bankruptcy. Zombies often become casualties to ...
  3. Witching Hour

    The last hour of stock trading between 3pm (when the bond market closes) and 4pm EST. Witching hour is typically controlled ...
  4. October Effect

    The theory that stocks tend to decline during the month of October. The October effect is considered mainly to be a psychological ...
  5. Repurchase Agreement - Repo

    A form of short-term borrowing for dealers in government securities.
  6. Correlation

    In the world of finance, a statistical measure of how two securities move in relation to each other. Correlations are used ...
Trading Center