What is the 'Implied Rate'

The implied rate is the difference between the spot interest rate and the interest rate for the forward or futures delivery date. For example, if the current U.S. dollar deposit rate is 1% for spot and 1.5% in one year's time, the implied rate is the difference of 0.5%. Or, if the spot price for a currency is 1.050 and the futures contract price is 1.110, the difference of 5.71% is the implied interest rate.

In both of these examples, the implied rate is positive, which indicates that the market expects future borrowing rates to be higher than they are now.

BREAKING DOWN 'Implied Rate'

The implied interest rate gives investors a way to compare returns across investments and evaluate the risk and return characteristics of that particular security. An implied interest rate can be calculated for any type of security that also has an option or futures contract.

To calculate the implied rate, take the ratio of the forward price over the spot price. Raise that ratio to the power of 1 divided by the length of time until the expiration of the forward contract. Then subtract 1.

implied rate = (forward / spot) raised to the power of (1 / time) - 1

where time = length of the forward contract in years

Example Implied Rate Calculations for Different Markets

 

Commodities Example:

 

If the spot price for a barrel of oil is $68 and a one-year futures contract for a barrel of oil is $71, the implied interest rate is:

implied rate = (71/68) -1 = 4.41 percent

Divide the futures price of $71 by the spot price of $68. Since this is a one-year contract, the ratio is simply raised to the power of 1 (1 / time). Subtract 1 from the ratio and find the implied interest rate of 4.41 percent.

Stocks Example:

If a stock is currently trading at $30 and there is a two-year forward contract trading at $39, the implied interest rate is:

implied rate = (39/30) raised to the (1/2) power - 1 = 14.02 percent

Divide the forward price of $39 by the spot price of $30. Since this is a two-year futures contract, raise the ratio to the power of 1/2. Subtract 1 from the answer to find the implied interest rate is 14.02 percent.

Currencies Example:

If the spot rate for the euro is $1.2291 and the one-year futures price for the euro is $1.2655, the implied interest rate is:

implied rate = (1.2655 / 1.2291) - 1 = 2.96 percent

Calculate the ratio of the forward price over the spot price by dividing 1.2655 by 1.2291. Since this is a one-year forward contract, the ratio is simply raised to the power of 1. Subtracting 1 from the ratio of the forward price over the spot price results in an implied interest rate of 2.96 percent.

RELATED TERMS
  1. Forward Margin

    The difference between the spot rate and the estimated future ...
  2. Forward Discount

    A forward discount occurs when the expected future price of a ...
  3. Spot Trade

    A spot trade is the purchase or sale of a foreign currency or ...
  4. Implied Authority

    Implied authority refers to an agent with the jurisdiction to ...
  5. Forward Rate

    A forward rate is an interest rate applicable to a financial ...
  6. Forward Exchange Contract

    A forward exchange contract is a special type of foreign currency ...
Related Articles
  1. Trading

    Implied volatility: Buy low and sell high

    The success of an options trade can be significantly enhanced by being on the right side of implied volatility changes.
  2. Trading

    Ratio Writing: A High-Volatility Options Strategy

    Selling a greater number of options than you buy profits from a decline back to average levels of implied volatility.
  3. Trading

    Forex: Gauging Forex Market Sentiment With Open Interest

    Examining open interest on currency futures can help you confirm the strength of a trend in forex market sentiment.
  4. Trading

    An Option Strategy for Trading Market Bottoms

    A reverse calendar spread offers a low-risk trading setup with profit potential in both directions.
  5. Investing

    Is American Eagle Now Too Cheap to Ignore?

    American Eagle stock is down 27 percent year to date. Examine its intrinsic and relative valuation.
  6. Trading

    Contango vs. Normal Backwardation

    Learn about the futures curve, contango and backwardation, and what they mean for hedgers and speculators.
  7. Personal Finance

    Consider All of Your Assets When Making Decisions

    When making a decision that could affect your finances, it's important to consider your real-time, implied and potential assets.
  8. Investing

    AMD Could Rise 10% Despite Results, Trades Indicate

    Advanced Micro stock tanked even though its 3Q earnings beat estimates because its 4Q outlook is weak.
  9. Investing

    Quantifying the Growth Implied by Snap's Valuation

    Based on an intrinsic valuation model, what is the growth rate implied by Snap's current price?
RELATED FAQS
  1. What is the Difference Between a Forward Rate and a Spot Rate?

    The forward rate is the settlement price of a forward contract, while the spot rate is the settlement price of a spot contract. Read Answer >>
  2. What is the relationship between implied volatility and the volatility skew?

    Learn what the relationship is between implied volatility and the volatility skew, and see how implied volatility impacts ... Read Answer >>
  3. How accurate is the forward rate in predicting interest rates?

    Find out why forward rates are inconsistent and limited predictors of actual future interest rates, primarily because the ... Read Answer >>
  4. Why is the initial value of a forward contract set to zero?

    Discover why the initial value of a forward contract is set to zero; read about financial mathematics and exchange logic ... Read Answer >>
  5. Why do futures' prices converge upon spot prices during the delivery month?

    Learn why as the delivery month of a futures contract approaches, the future's price will generally inch toward or even come ... Read Answer >>
Hot Definitions
  1. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  2. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
  3. Relative Strength Index - RSI

    Relative Strength Indicator (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent ...
  4. Dividend

    A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders.
  5. Inventory Turnover

    Inventory turnover is a ratio showing how many times a company has sold and replaces inventory over a period.
  6. Watchlist

    A watchlist is list of securities being monitored for potential trading or investing opportunities.
Trading Center