Spot Rate vs. Forward Rate: An Overview

A spot rate is the current market price at which a stock, bond, commodity, or currency can be purchased or sold. A forward rate or forward price is a price set in ad🐈vance between a buyer and a seller for execution on a future date.

The term has its origin in the commodities futures markets, where the spot rate is the agreed price for an immediate or "on the spot" transaction.

There are small differences in terminology among markets: In the commodities markets, traders refer to the "forward price" instead of "forward rate" because it is the settlement price (not rate) of a transaction that will take place at a predetermined date.

And༺, in the bond markets, t💧he forward rate refers to the effective yield on a bond, commonly U.S. Treasury bills, and is calculated based on the relationship between interest rates and maturities.

Spot Rate

A 澳洲幸运5开奖号码历史查询:spot rate or spot price is the real-time price quoted for the instant settlement ༒of a contract.

A spot rate in the commodities market indicates an immediate need for a commodity, with a delivery date usually falling within two business days of the trade date. Regardless of price fluctuations between the settlement and delivery dates, the contrꦦact will be completed at the agreed-upon spot rate.

When acting on a spot rate, both the buyer and the seller are giving up the chance of a more favorable price in the future while eliminating the risk of an adverse pricꦑe movement.

An example of a buyer relying on spot rates is a restaurant produce supplier that needs fresh ingredients for this week's business. The supplier must pay the current market price to receive the goods on time. On the other side of the transaction, a local farmer may have produce that will go bad if not sold within the next week.

Forward Rate

Both buyers and sellers ma꧃y choose to plan ahead, eliminating uncertainty by agr🌜eeing on a forward rate.

Commodities

A forward rate is a spe💛cified price agreed to by a buyer and a seller for the delivery of a good at a specific date in the future. The use of forward rates can be speculative if a buyer 🥀believes the future price of a good will be higher than the current forward rate.

Sellers use forward rates to m🌼itigate the risk that the future price of a good will materially decrease.

Regardless of the prevailing spot rate when the forward rate meets maturity, the agreed-upon contract is exe𒀰cuted at the forward rate. For example, on January 1st, the spot rate of a case of iceberg lettuce is $50. The restaurant and the farmer agree to the delivery of 100 cases of iceberg lettuce on July 1st at a forward rate of $55 per case.

On July 1st, even ifꩲ the price per case has decreased to $45/case or increased to $65/case, the contract will proceed at $55/case.

Bonds

The 澳洲幸运5开奖号码历史查询:forward rate for a bond ༺is calculated by comparing the future 澳洲幸运5开奖号码历史查询:expected yield of two bonds.

The forward rate is the y▨ield that will be earned if proceeds from the bond maturing earlier are re-invested to match the term of the bond maturing later.

How to Calculate the Forward Rate for a Bond

The formula for the one-year forward rat🐟e for a two-year bond is:

| { [ ( 1 + Rate_n1 )ⁿ¹ ÷ ( 1 + Rate_n2 )ⁿ² ] ÷ [ (Rate_n1 - Rate_n2 ) ] } -1 | * 100

Where:

• Rate_n1 = Spot rate for the two-year bond
• Rate_n2 = Spot rate for one-year bond
• n1 = Number of years for the first bond
• n2 = Number of years for the second bond

Imagine the spot price for the two-year bond is 3.996%🔯, and the one-year bond rate is 4.790%

The steps to calculate the forward rate areಌ as𝔉 follows:

1. Determine the expected future return of the two-year bond. This is calculated as (1 + .03996)² = 1.081516802.
2. Determine the expected future return of the one-year bond. This is calculated as (1 + .04970)¹ = 1.0497.
3. Divide the results obtained in steps 1 and 2. In this example, the result is 1.03.
4. Divide the result obtained in step 3 by the difference in the number of periods between the two bonds, then subtract one from the result. In this example, 1.0303% is divided by 1 (2 years - 1 year), and one is subtracted. Multiply by 100 to get a percent, and you get a result of 3.03% for the one-year forward rate.

Special Considerations

The terms spot rate and forward rate are applied a little different🍌ly in bond and curre🐼ncy markets.

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 澳洲幸运5开奖号码历史查询:nearer to maturity, the forward rate on the bond will be higher 🦩tha🌞n the interest rate on its face.

For example, consider a $1,000 two-year bond with a 10% interest rate. If the bond is purchased on the issuance date, the expected yield on the bond over the next two years is 10%. If an investor plans on buying the bond one year from issuance, the forward rate or price the investor should expect to pay is $1,100 ($1,000 + the 10% accumulated earnings generated from the first year). If the investor is lucky enough to purchase the bond in a year for less than this price, the expected yield will be greater than the coupon rate on the face of the bond.

The forward rate of a commodity, security, or currency can be determined using the current spot rate of the go🙈od, and the spot rate can be determined using the forward rate. This relationship closely mirrors the relationship between a discounted present ꦚvalue and a future value.

As long as an expected yield rate is known and the time frame has been determined, the change from spot rate to forward rate is an exercise of conve💃rting a present value to a future value or vice versa.

The Bottom Line

The forward rate is the price a trader agrees to pay for an investment on a future date. The spot rate is the price a trader will pay at that moment to pur💖chase an investment.