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Forward rate

The interest rate for a future period implied by today's spot rates; what the market is effectively pricing in for borrowing later.

If you can lock 4.5% for two years or 4.8% for one year, the market is implying a rate for year two that makes the two paths equal. Solving (1.045)^2 = 1.048 x (1 + f) gives a one-year forward rate one year out of about 4.20%.

Forwards are what rate traders actually trade against. Saying you are bullish rates is meaningless unless yields end up below the forwards, because the forwards are already in the price. Every bond's carry-fixed-income is a bet that the forwards do not come true.

Example: forwards imply the 2-year yield will be 3.90% in one year's time. If you think it will be 3.40%, buying the 2-year and holding is the expression; if you think 4.40%, you sell it.

Related: spot-rate, carry-fixed-income, roll-down, expectations-hypothesis

See it drawn

Original diagrams for the ideas on this page. Illustrative, not real market data.

Contango and backwardationTwo futures curves against contract expiry: one rising above spot, one falling below it.The same commodity, priced for delivery at different dates.78.0076.0074.0072.0070.00Futures pricespot+1m+2m+3m+4m+5m+6mMonths until the contract expiresspot price74.00CONTANGOlater contracts cost more than spotBACKWARDATIONlater contracts cost less than spot
Contango and backwardation. A futures curve shows what buyers will pay for delivery in one month, two months and so on. When later contracts cost more than the spot price the curve is in contango; when they cost less it is in backwardation.

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