Bond Prices: Spot Rates and Forward Rates

 Spot rates is nothing but the price that is quoted for commodity or security or a currency at the current position. It is usually quoted for immediate deliveries which are usually two days from the traded date. It is also called as benchmark rate or straight forward rate or out right rate. Forward rates are the prices that are quoted for the execution of the contract in the future date. Contract formalities are quoted now but the settlement and the execution of the contract are done in the future. The price used in this method is termed as forward prices. It is also called as speculative rate.

 The spot price determines the future price. It might not be same in all the case. In case of security and non perishable commodity the spot price is used to find out the future price. The future price is nothing but the expectation of the profit that the person holding the future might yield from those commodity or security. The financial charges too have some impact in the future price in the above case.

In case of non perishable commodity the spot rates and future rates are independent. The cost of storage is quite high in these commodities. It is therefore not possible to predict the future price of such commodities. The spot price of these commodities varied invariably with respect to the future price.  The commodity trades usually don’t have these futures for those perishable commodities mainly because of the above reason.

Some of the differences between two rates are,

• Spot rate are not speculative. Forward rate are highly speculative.
• Spot rate are fixed. Forward rate varies drastically with time.
• Spot rate usually don’t have interest attached to it. Forward rate usually have some interest rate attached to it.
• Spot rate variation is less. Forward rate vary drastically with speculation.

Question

• What are the difference between spot rate and forward rate?
• In which circumstance spot rate and forward rate vary drastically?