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. Commodity

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

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

    A contractual agreement, generally made on the trading floor ...
  6. Delivery Date

    1. The final date by which the underlying commodity for a futures ...
Related Articles
  1. Options & Futures

    Interpreting Volume For The Futures Market

    Learn how to read the volume reports, look at the relation to liquidity and interpret volume using open interest.
  2. Options & Futures

    Options On Futures: A World Of Potential Profit

    There's one simple hurdle in the transition from stock to futures options: learning about product specifications.
  3. Insurance

    Futures Fundamentals

    For those who are new to futures but want a solid understanding of them, this tutorial explains what futures contracts are, how they work and why investors use them.
  4. Chart Advisor

    Cocoa Prices Setting Up For A Move Lower

    Cocoa prices have been trending lower over the past several months and the recent bearish crossover between the 50-day and 200-day moving averages suggest that the long-term downtrend is gaining ...
  5. Options & Futures

    What are the differences between divergence and convergence?

    Find out what technical analysts mean when they talk about a market experiencing divergence or convergence and how they affect trading strategies.
  6. Options & Futures

    Futures Quotes Explained The "Easy" Way

    If there’s a security whose price fluctuates, there can theoretically be a futures marketplace for it.
  7. Trading Strategies

    Is the Stock Correlation Strategy Effective?

    The synchronized movement among stocks and markets in recent years is challenging diversification.
  8. A commodity is a basic good used in commerce.
    Markets

    What are Commodities?

    A commodity is a basic good used in commerce that is interchangeable with other commodities of the same type. Commonly traded commodities include gold, beef, oil, lumber and natural gas. Additional ...
  9. Options & Futures

    Why is the Accumulative Swing Index helpful for traders and/or investors?

    Find out why J. Welles Wilder believed that the accumulative swing index could be used in the futures markets to indicate long-term trends.
  10. Options & Futures

    Stock Futures vs Stock Options

    A full analysis of when is it better to trade stock futures vs when is it better to trade options on a particular stock. A quick overview of how each of them works and why would a trader, investor, ...

You May Also Like

Hot Definitions
  1. Deferred Revenue

    Advance payments or unearned revenue, recorded on the recipient's balance sheet as a liability, until the services have been ...
  2. Multinational Corporation - MNC

    A corporation that has its facilities and other assets in at least one country other than its home country. Such companies ...
  3. SWOT Analysis

    A tool that identifies the strengths, weaknesses, opportunities and threats of an organization. Specifically, SWOT is a basic, ...
  4. Simple Interest

    A quick method of calculating the interest charge on a loan. Simple interest is determined by multiplying the interest rate ...
  5. Special Administrative Region - SAR

    Unique geographical areas with a high degree of autonomy set up by the People's Republic of China. The Special Administrative ...
  6. Annual Percentage Rate - APR

    The annual rate that is charged for borrowing (or made by investing), expressed as a single percentage number that represents ...
Trading Center