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Forward Interest Rate Calculator

Forward Rate Equation:

\[ Forward = \left( \frac{(1 + Long\ Rate)^{long}}{(1 + Short\ Rate)^{short}} \right)^{\frac{1}{(long - short)}} - 1 \]

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1. What is the Forward Interest Rate?

The forward interest rate is the future interest rate implied by current interest rates for different maturities. It represents the break-even rate that would equalize the total return between two different investment strategies.

2. How Does the Calculator Work?

The calculator uses the forward rate equation:

\[ Forward = \left( \frac{(1 + Long\ Rate)^{long}}{(1 + Short\ Rate)^{short}} \right)^{\frac{1}{(long - short)}} - 1 \]

Where:

Explanation: The equation calculates the implied future rate that would make an investor indifferent between investing for the long term or investing for the short term and then reinvesting at the forward rate.

3. Importance of Forward Rate Calculation

Details: Forward rates are essential for fixed income analysis, interest rate derivatives pricing, and understanding market expectations of future interest rates.

4. Using the Calculator

Tips: Enter all rates as decimals (e.g., 5% = 0.05). The long period must be greater than the short period. All values must be positive numbers.

5. Frequently Asked Questions (FAQ)

Q1: What's the difference between spot rates and forward rates?
A: Spot rates are current rates for specific maturities, while forward rates are implied future rates between two future dates.

Q2: How are forward rates used in practice?
A: They're used to price forward rate agreements (FRAs), interest rate swaps, and to assess market expectations of future rate changes.

Q3: What does a higher forward rate indicate?
A: It suggests the market expects interest rates to rise in the future between the two time periods.

Q4: Can forward rates predict future interest rates?
A: They reflect market expectations but aren't perfect predictors as they don't account for risk premiums and other factors.

Q5: How does compounding frequency affect the calculation?
A: The formula assumes rates are for the same compounding period. Adjustments are needed for different compounding frequencies.

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