Forward rate
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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]
Contents
Forward rate calculation
To extract the forward rate, one needs the zero-coupon yield curve. The general formula used to calculate the forward rate is:
Simple rate
Compound rate
Exponential rate
is the forward rate between term and term ,
is the time length between time 0 and term (in years),
is the time length between time 0 and term (in years),
is the zero-coupon yield for the time period ,
is the zero-coupon yield for the time period ,
Derivation
We are trying to find the future interest rate for time period , given the rate for time period and rate for time period . To do this, we solve for the interest rate for time period for which the proceeds from investing at rate for time period and then reinvesting those proceeds at rate for time period is equal to the proceeds from investing at rate for time period . Or, mathematically:
Solving for yields the above formula.
Related instruments
See also
References
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