Forward rate

The forward rate ( English forward rate ) is the price of a financial instrument or commodity ( commodities ) on futures contracts on the futures market . The opposite is the spot rate .

General

Forward rates belong to the stock exchange rates in addition to the spot rates. The forward rates are considered to be the most important market data that is of interest not only to market participants but also to the general public . The forward rate is (the day of the transaction English trade date agreed) between the parties and the settlement date ( English settlement date ) - regardless of the current share price - based on the futures market. If you multiply the forward rate by the unit ( nominal value or number of units ) of the underlying , you get the market value . As a predictor , the forward rate contains - more or less certain - forecasts of the future market development of the spot rate of an underlying and thus anticipates future market prices .

species

Forward rates exist for securities , foreign exchange ( financial instruments ) and raw materials such as coffee (or other commodities).

For securities, forward prices play a role, especially for stocks . Securities futures are transactions with a firmly agreed rate (forward rate) that are to be fulfilled by delivery and payment on a specific date agreed in advance . In stock trading , the forward price results from the inclusion of any dividends that are received during the term of the forward transaction and the interest expense for a Lombard loan taken out or the opportunity costs for a lost investment . Then the forward price of a share corresponds to the compounded current spot price, there is no arbitrage . In contrast to this, the (securities) option transaction is not to be performed on a specific date, but rather during a specified period .

The forward rate plays a crucial role in foreign exchange. When forward contract the forward rate from a lower consists bid price ( English bid ), a higher ask price ( English ask ), and an intermediate arithmetical mean rate ( English mean rate ). The latter is determined by applying the fixed rate spreads for each currency from the bid and ask rates. Forward exchange rates are available on futures exchanges and in over-the-counter interbank trading . The German currency futures trading ( "currency futures trading") became established after December 1871, when in Germany need to hedge against the exchange risk of no gold parity equipped ruble was.

In the commodity markets , the forward rate is usually quoted above the spot rate, because raw material purchases are usually made through forward transactions. In addition, in a cash transaction for securities or raw materials, capital and storage costs must be used so that the interest and storage costs ( English cost of carry ) increase the spot rate and the income attributable to the underlying assets (dividends, interest on securities, rental prices) reduce it. Only at the end of the term of the futures contract do the forward and spot rates match due to the ongoing convergence process. A seller who has the choice between both market segments will prefer the lower spot rate and invest the sales proceeds with interest if he is not compensated by a correspondingly higher forward rate for lost interest income and storage costs. In the upswing , inventory levels gain in importance for commodities , the spot rate rises above the forward rate ( backwardation ), which approaches the spot rate (on the futures market, not in a forward transaction) until maturity . In the downturn , the spot rates fall below the forward rates ( contango ), the reverse development occurs.

Spot rate as reference rate

Normally, the spot and forward rates of a certain underlying differ from one another. The difference between the two rates depends on the term of the futures contract, the interest rate difference between two countries (for interest-bearing financial instruments ), the storage costs (for goods), the risk premium and the expected value. If the forward rate in quantity rate under the spot rate, then the difference as Deport ( tee , English discount ) denotes:

${\displaystyle Deport=Terminkurs<Kassakurs}$.

In this case, the comparable interest rates abroad are lower than in Germany and a devaluation of the foreign currency is expected. If the forward rate is higher than the spot rate, it is a report ( premium , English premium ):

${\displaystyle Report=Terminkurs>Kassakurs}$.

The foreign interest level is higher than in Germany, an appreciation of the foreign currency is expected. The situation is reversed when quoted prices .

Since spot and forward rates generally do not match, the swap rate is calculated as the relative difference between the forward rate and the spot rate in relation to the spot rate ( percent per annum ):

${\displaystyle {\text{Swapsatz}}={\frac {{\text{Terminkurs}}-{\text{Kassakurs}}}{\text{Kassakurs}}}\cdot {\frac {\text{360}}{\text{1}}}\cdot 100}$

If the difference between the spot rate and the forward rate is greater than the swap rate, there are arbitrage opportunities , but not for goods because of the storage costs incurred. The difference between the spot rate and the forward rate grows - except for an indifference margin - until arbitrage is no longer worthwhile.

International

Internationally as in Germany, the forward rate is the counterpart to the spot rate. It is to be used in the EU member states for forward transactions that are to be fulfilled later than two working days after the transaction. Forward rates are also available on Anglo-Saxon bond markets and for commodities, including the London Metal Exchange and the New York Mercantile Exchange for base metals and for energy on the European Energy Exchange .

Economic importance

According to the interest parity theory developed by John Maynard Keynes in 1923 , the formation of forward rates is determined by the gross interest rate differential between two currencies. It assumes that if there is a gross interest rate differential, there will be interest-oriented money movements from the low-interest to the high-interest country until the advantage of investing in the high-interest country is offset by rising exchange rate hedging costs. According to Keynes, in functioning financial markets , any combination of currencies corresponds to the swap rate, otherwise the interest rate adjustment arbitrage ensures market equilibrium . An equilibrium relationship between spot and forward rate is achieved when the deport / report is so large that the advantage / disadvantage of the higher / lower interest rate on the foreign currency is just offset. As soon as the exchange rate hedging costs deviate from interest parity, interest rate arbitrage sets in and brings the ratio of spot and forward rates into line with the interest rate differential. The validity of the interest parity theory is affected by financial and political risks ( market disturbances , unrest , foreign exchange control , moratoriums ), as Keynes already pointed out.

In normal market conditions, the forward rate follows the spot rate at roughly the same distance - with the interest rate differential unchanged - under the influence of interest rate arbitrage. If the market situation is abnormal, however, the forward rate moves independently of the spot rate, even if the gross interest rate differential remains unchanged. The forward rate generally does not provide a good forecast for the future spot rate because risk premiums and expectation errors have to be taken into account. If the expectations based on available information regarding the price levels higher than the current spot rates, the forward rates will be higher than the spot price, and vice versa.

Arbitrage aligns the spot and forward prices of an underlying asset, because market participants will stock up on a lower spot rate on the cash market and fulfill their forward sales on the futures market and vice versa. This leads to an increase in the spot rate and a decrease in the forward rate (and vice versa), so that both rates move towards each other.

The presence of a futures market and forward rates improves the information provided to market participants about future market developments , so that spot and forward rates form the basis for forecasting the future market development of an underlying asset. In addition, the forward rate leads to an improvement in the allocation of market price risks .

Individual evidence

1. ↑ Erich Ammenhäuser, The securities futures trading on the German stock exchanges , 1928, p. 9
2. ↑ Günter Franke / Herbert Hax, Finanzwirtschaft des Unternehmens und Kapitalmarkt , 1994, p. 364
3. ↑ Erich Waclawik, The binding nature of foreign exchange date agreements , 2000, p. 37
4. ↑ Hannes Enthofer / Patrick Haas, Handbuch Treasury / Treasurer's Handbook , 2012, p. 561
5. ^ Hermann-Josef Dudler, Discount and Forward Rate Policy , 1969, p. 31
6. ^ John Maynard Keynes , A Tract on Monetary Reform , 1923, p. 127
7. ^ John Maynard Keynes, A Tract on Monetary Reform , 1923, pp. 115 ff.
8. ↑ Erich Waclawik, The liability of foreign exchange date agreements , 2000, p. 76
9. ↑ Werner Steuer, Die Aufwertungsspekulation , 1969, p. 34
10. ^ John Maynard Keynes, A Tract on Monetary Reform , 1923, pp. 129 f.
11. ↑ Werner Steuer, Die Aufwertungsspekulation , 1969, p. 36
12. ↑ Eberhard Müller-Schwerin / Günter Faltin, The stock exchange trading with securities , 1975, p. 35 f.