Bond Forward Rates


In simple terms, bond forward rates are the future interest negotiated by two parties in a contract. The seller of the forward rate is agreeing to sell a bond at a rate and maturity date in the future. Bond forward rates may be based on published rates, but they can also be gauged based on current or forecasted rates.

More About Bond Forward Rates

Continue reading to learn more about:

What is the forward rate on bonds?
How does a forward rate agreement work?
What is a forward rate example?
What is the spot rate and forward rate for bonds?
How do you calculate the forward rate of a bond?


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What is the forward rate on bonds?


The forward rate is a rate of interest applicable to a bond that can be agreed and specified today but that applies to a period in the future, agreed and specified at the time the contract is drawn up. The bond forward rate is the market-implied interest rate for loans in a future period, or "forward tenor". It is calculated from the current spot rates of bonds with similar maturities. The spot rate is the interest rate on a bond that matures immediately.


 
 

How does a forward rate agreement work?


Forward Rate Agreements (FRAs), also called Forward Contracts, provide protection against interest rate movements that may impact your business. These agreements are financial instruments between two parties whereby one party will pay the other a fixed interest rate from a given date to a future date based on a specified principal, and in exchange for paying this fixed interest rate, the other party receiving it will pay the agreed floating interest rate.

 

What is a forward rate example?

A forward interest rate agreement (FRA) is an OTC contract between two parties where one party pays a fixed interest rate and the other party pays a floating interest rate based on a specified notional amount for a specific period of time.
A forward contract may be a custom-tailored, one-time transaction or it may be a standard unit of a specified amount.
 
  • What is the spot rate and forward rate for bonds?

    A spot rate is the interest rate at which a bond’s price equals its face value. A "forward rate" is the interest rate prevailing on a given date for bonds maturing further into the future. The forward rate is considered a theoretical construct since it is not traded on an exchange but is implied by converting discount rates and spot rates between different maturity dates.
  • How do you calculate the forward rate of a bond?

    The forward rate is calculated by way of a formula called the unbiased expectation theory, which takes into account not only the current bond, but also the spot rate of similar bonds. The longer a bond has to maturity, the more comparison options are available.