Forward Rate Calculator

Formula

The formula to calculate the Forward Rate (FR) is:

\[ FR = \left( \frac{(1 + S_1)^{N_1}}{(1 + S_2)^{N_2}} \right)^{\frac{1}{N_1 - N_2}} - 1 \]

Where:

\(FR\) is the forward rate
\(S_1\) is the spot rate until a further future date
\(S_2\) is the spot rate until a closer future date
\(N_1\) is the number of years until the further future date
\(N_2\) is the number of years until the closer future date

Forward Rate Definition

A forward rate in finance is the predetermined exchange rate for a future currency transaction. It represents the rate at which one currency can be exchanged for another at a specific time in the future. This type of rate is commonly used in international trade and investment to mitigate the risk arising from exchange rate fluctuations.

By utilizing forward rates, businesses and investors can establish contracts or agreements to exchange currencies at a fixed rate on a specified future date. This allows them to hedge against potential losses resulting from unfavorable currency movements.

Example Calculation

Let's assume the following values:

Spot Rate Until a Further Future Date (S₁) = 0.05
Spot Rate Until a Closer Future Date (S₂) = 0.03
Number of Years Until the Further Future Date (N₁) = 5
Number of Years Until the Closer Future Date (N₂) = 2

Using the formula to calculate the Forward Rate (FR):

\[ FR = \left( \frac{(1 + 0.05)^5}{(1 + 0.03)^2} \right)^{\frac{1}{5 - 2}} - 1 \approx 0.0064 \]

The Forward Rate (FR) is approximately 0.0064or 0.64%.