The forward rate is the future yield on a bond. It is calculated using the yield curve.
For example, the yield on a three-month Treasury bill six months from now is a forward rate [1].
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Forward rate calculation
In order to extract the forward rate, one needs the term structure of interest rates. The general formula used to calculate the forward rate is:
Where
r1,2 is the forward rate between term t1 and term t2 ,
d1 is the time length between time 0 and term t1 (in years),
d2 is the time length between time 0 and term t2 (in years),
r1 is the interest rate for the period time 0 to term t1 ,
r2 is the interest rate for the period time 0 to term t2 ,
Related instruments
A forward discount is when the forward rate of one currency relative to another currency is higher than the spot rate. A forward premium is when the forward rate of one currency relative to another currency is lower than the spot rate.
See also
Notes
- ^ Fabozzi, page 148
References
- Fabozzi, Frank J: The Handbook of Fixed Income Securities, Seventh Edition, McGraw Hill, 2005
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