1. What is the Forward Rate Formula (CFA Approximate)?

Definition: This formula calculates the implied forward interest rate between two future periods based on current spot rates.

Purpose: Used in fixed income analysis to determine the expected future interest rate between two time periods.

2. How Does the Formula Work?

The formula is:

Where:

• \( f \) — Forward rate (decimal)
• \( r_{long} \) — Long-term spot rate (decimal)
• \( long \) — Long-term period (years)
• \( r_{short} \) — Short-term spot rate (decimal)
• \( short \) — Short-term period (years)

Explanation: The formula calculates the break-even rate that would make an investor indifferent between investing for the long term or investing short-term and rolling over at the forward rate.

3. Importance of Forward Rate Calculation

Details: Forward rates are essential for bond valuation, interest rate derivatives pricing, and understanding market expectations of future interest rates.

4. Using the Calculator

Tips: Enter the long-term and short-term spot rates (in decimal form, e.g., 0.05 for 5%), and their respective periods in years. The long-term period must be greater than the short-term period.

5. Frequently Asked Questions (FAQ)

Q1: What's the difference between exact and approximate forward rate formulas?
A: The exact formula uses geometric compounding (1+r)^n, while this approximation uses simple linear interpolation.

Q2: When would I use this approximation?
A: For quick estimates or when the time periods are relatively short and rates are low.

Q3: How do I convert decimal rates to percentages?
A: Multiply by 100 (e.g., 0.05 = 5%).

Q4: What if my forward rate is negative?
A: Negative forward rates can occur in unusual market conditions and imply expectations of future rate decreases.

Q5: How accurate is this approximation?
A: It's reasonably accurate for short time horizons and low interest rates, but becomes less precise for longer periods or higher rates.