Future interest rate implied by today's term structure, widely used in curve analysis, hedging, and rate derivatives.
A forward rate is a future interest rate implied by today’s curve or agreed today for future settlement. In fixed income, it is the rate the current term structure implies for a later borrowing or lending period.
Forward rates matter because they help investors connect today’s yield curve to future rate periods without pretending the market sees the future with certainty.
They are used in:
| Measure | What it represents | Best use | Main limitation |
|---|---|---|---|
| Spot Rate | Current prompt settlement rate or one exact maturity discount rate | Immediate pricing point | Not a future-period rate |
| Forward Rate | Future-period rate implied by today’s structure | Curve analysis and hedging | Not a guaranteed forecast |
| Realized Future Short Rate | Rate that actually prevails later | Ex post outcome | Unknown today |
If \(s_1\) is the one-year spot rate and \(s_2\) is the two-year spot rate, the one-year forward rate starting one year from now can be written as:
If:
4%5%then:
A forward rate tells the desk what future period is embedded in today’s curve. Traders compare forwards across maturities to judge whether parts of the curve look rich, cheap, steep, or flat.
If the curve implies a high one-year forward rate one year from now, the market is effectively pricing a tighter future rate environment for that later period, even though the realized rate could turn out lower or higher.
It is a price implied by today’s curve, not a guaranteed prediction of where short rates will actually settle.
The term also appears in FX and other future-settlement contexts, but in fixed income the usual meaning is an implied future interest rate from the term structure.