Finance Question about calculating forward rate from spot rates?
Great answer John. Great answer perplexed. I think that it is often useful to see what the current yield curve shows about forward rates, and also how changes in the current yield curve reflect expected changes in forward rates. You could do this by using this Excel spreadsheet: http://www.ronakke.com/Forward-Rates-VBA.html
How do you calculate two year forward rates using zero coupon rates? Plz help!?
Now, first let me clarify the definition, F(1,3) is a 2-year forward rate 1 year from now, F(2,4) is 2-year forward 2 years from now, etc. Say if you want to invest for 3 years, you could a) buy a 3-year zero coupon that matures in 3 years' time or b) buy a 1-year zero, then invest the proceeds at maturity (after one year) in a 2-year zero coupon (note, this is forward), for a total of 3 years. The returns will be the same whether you do a) or b), right? Otherwise arbitrage opportunities will present itself. Therefore either option must give equal returns, i.e. (1+ 3-year ZCR)^3 = (1 + 1-year ZCR) * (1 + F(1,3))^2 Solve for F(1,3) and you will have your forward rate. Likewise, working from the same principle, invest for 4 and 5 years, F(2,4) and F(3,5) can be solved using (1 + 4-year ZCR)^4 = (1 + 2-year ZCR)^2 * (1 + F(2,4))^2 and (1 + 5-year ZCR)^5 = (1 + 3-year ZCR)^3 * (1 + F(3,5))^2 If you think this is a decent answer, could you donate £5 to NSPCC, I don't need the money but I think the children does... (http://www.nspcc.org.uk/donate/donatehub_wda36430.html) Many thanks!
Why would the forward rate be less than the spot rate?
All of the answers given so far haven’t even touched on the economics of this question, since this is an economic (and not mathematical) question.There have been many theories put forward to explain the disparity between spot rates and forward rates, most of them pandering to the scenario of forward rates being higher than spot rates.The only applicable and renowned theory I know of that could be used to answer your question is the Market Segmentation Theory.Under this theory, there are two key assumptions:Bonds of different maturities have distinct investor classes (clientele effect).Prices of bonds and securities are determined by supply and demand, not by our theoretical pricing models (we tend to assume this is the case most of the time anyway).Thus, the implication is simply this: if forward rates are lower than spot rates, then we know that there is a higher demand for long-term securities.This is essentially the theory behind quantitative easing, where the Federal Reserve purchases long-term bonds in high quantities to drive down their yields. The effect is supposed to introduce an influx of cash into the economy and provide stimulus.We can infer this conclusion because of the inverse relationship between bond yields and bond prices. If bond prices increase, which happen where there is high demand, then bond yields would decrease. In your question’s scenario, investors are heavily purchasing long-term securities and thus drive down their yields, ultimately lowering forward rates.
What is forward rate and spot rate?
You mean fx or something else? Doesn’t really matter just dividends and coupons complicate stuff.Anyway spot is price you buy or sell today (even that is complicated by settlement lag but let us ignore that).Forward price is what you would agree to buy or sell at in the future. It is different because of interest rates or assets earning or costing stuff in mean time.Look at no arbitrage theory. If you have cash buy stuff today enter contract to sell it in one year. You have no net position so net risk free so that should be your return same as if you just bought risk free asset, often assumed to be treasuries though people use other stuff and weirdness like swap -ve spreads complicate things, blame Goldman, Lehman, AIG, regulators and idiots who bought/sold adjustable rate mortgages thinking it was somebody elses problem…..The price difference will or should depend on what it earns in interim, cost of holding it. For fx it is easy, interest differential. Others more complex like dividends stock borrow rates but idea is same.TL;DR you want a dollar today or tomorrow, time value.
What is spot rate,forward rate and currency swap?any examples?
The spot price or spot rate of a commodity, a security or a currency is the price that is quoted for immediate (spot) settlement (payment and delivery). The forward price or forward rate is the agreed upon price of an asset in a forward contract. Using the rational pricing assumption, we can express the forward price in terms of the spot price and any dividends etc., so that there is no possibility for arbitrage. A currency swap is a foreign exchange agreement between two parties to exchange a given amount of one currency for another and, after a specified period of time, to give back the original amounts swapped.
Why would forward rates differ from actual spot rates?
If the speculators in the market were risk neutral and there were no transaction costs, then the forward rate would be equal to the market's expected future spot rate. This is so because, otherwise it would be possible to buy in one market and sell in the other to make profits. Let us take the case where the forward rate is lower than the expected spot rate. In such a case, the speculator would buy a forward contract expecting to sell in the spot market in the future at a higher price. The resulting increased demand in the forward market would increase the forward rate and drive it towards equalization with the expected future spot rate. If the forward rate is higher, speculators would sell in the forward market, thus pushing the forward rate down. In reality however, there is also a risk of the spot rate turning out to be different from the expected spot rate and the speculators are not really risk neutral. They expected to be compensated for the risk they take on. In addition, there is the presence of transaction costs to be contended with. These two factors result in the forward rate being different from the spot rate to some extent.
How do you calculate a spot rate given forward rates?
Im assuming you are asking on fixed income instrument spot rate (Im simplifying it alot here for understanding).Spot rate is the current interest rate for any given time period. Year spot rate% forward rate 1 5% same 5% 2 6% 3 7%The theory is the compound rates per year has to be the same (no arbitrage), i.e(1+7%)^3 = (1+6%)^2*(1+forward rate at t=3)So forward rate is akin to a implied spot rate.To calculate spot from forward, just reverse. And thats the theory.
Are forward exchange rates just a reflection of interest rate parity or are they the consensus exchange rate a future point in time?
I would argue that the forward only reflects the no arbitrage parity ( interest rates diferential).Of course expectations do influence the forward interest rates in both currencies . But every time the currency forward goes away from the no arbitrage parity, there are player who arbitrate. So it comes back.
Finance question (interest rate parity)?
I've got to say that your additional details made me laugh. Happy to help anyone who makes me laugh. First off, recognize that since the US interest rate is higher than the Canadian interest rate, in the future the USD will depreciate (and vice versa: i.e. since CAD interest rate is lower, CAD will appreciate) - this is a good way to spotcheck whether your answer is correct. That said, I'm a bit confused on your quote. Usually a quote of CAD/USD means one CAD buys $1.0698 USD. See the section "Syntax and Quotation" here: http://en.wikipedia.org/wiki/Base_curren... ...but I think you might mean $1USD buys $1.0698 CAD, so... here's your equation (assuming 1 USD buys $1.0698 CAD in the forward exchange rate): (1 + CAD int. rate) = (fwd rate / spot rate)(1 + US int. rate).....(also see NOTE below) 1.04325 = 1.0698/spot * 1.0454 ...rearrange 1.04325/1.0454 = 1.0698/spot 0.997943 = 1.0698 / spot spot = 1.0698 / 0.997943 spot = 1.072005 (
What is the difference between a forward rate and a future spot rate?
A forward rate is the amount someone will agree today to pay for something at a specified future time. The future spot rate is what someone will agree to pay at that future time.For example, a month ago the forward price for a barrel of Brent Crude was about $48. You could have found someone willing to sell you 1,000 barrels for $48,000, with both oil and money changing hands today. However, if you waited until today to buy your oil, you’d pay $52,000. In this case you would saved $4,000 by using a forward contract a month ago; and the oil seller would have lost the same $4,000.Although you might think that the forward rate is a good predictor of the future spot rate, it actually isn’t very good, which is one of many reasons that traders can make money.