# Forward rate

The forward rate is the future yield on a bond. It is calculated using the yield curve. For example, the yield on a three-month Treasury bill six months from now is a forward rate.[1]

## Forward rate calculation

To extract the forward rate, we need the zero-coupon yield curve.

We are trying to find the future interest rate ${\displaystyle r_{1,2}}$ for time period ${\displaystyle (t_{1},t_{2})}$, ${\displaystyle t_{1}}$ and ${\displaystyle t_{2}}$ expressed in years, given the rate ${\displaystyle r_{1}}$ for time period ${\displaystyle (0,t_{1})}$ and rate ${\displaystyle r_{2}}$ for time period ${\displaystyle (0,t_{2})}$. To do this, we use the property that the proceeds from investing at rate ${\displaystyle r_{1}}$ for time period ${\displaystyle (0,t_{1})}$ and then reinvesting those proceeds at rate ${\displaystyle r_{1,2}}$ for time period ${\displaystyle (t_{1},t_{2})}$ is equal to the proceeds from investing at rate ${\displaystyle r_{2}}$ for time period ${\displaystyle (0,t_{2})}$.

${\displaystyle r_{1,2}}$ depends on the rate calculation mode (simple, yearly compounded or continuously compounded), which yields three different results.

### Simple rate

${\displaystyle (1+r_{1}t_{1})(1+r_{1,2}(t_{2}-t_{1}))=1+r_{2}t_{2}}$

Solving for ${\displaystyle r_{1,2}}$ yields:

Thus ${\displaystyle r_{1,2}={\frac {1}{t_{2}-t_{1}}}\left({\frac {1+r_{2}t_{2}}{1+r_{1}t_{1}}}-1\right)}$

The discount factor formula for period (0, t) ${\displaystyle \Delta _{t}}$ expressed in years, and rate ${\displaystyle r_{t}}$ for this period being ${\displaystyle DF(0,t)={\frac {1}{(1+r_{t}\Delta _{t})}}}$, the forward rate can be expressed in terms of discount factors: ${\displaystyle r_{1,2}={\frac {1}{t_{2}-t_{1}}}\left({\frac {DF(0,t_{1})}{DF(0,t_{2})}}-1\right)}$

### Yearly compounded rate

${\displaystyle (1+r_{1})^{t_{1}}(1+r_{1,2})^{t_{2}-t_{1}}=(1+r_{2})^{t_{2}}}$

Solving for ${\displaystyle r_{1,2}}$ yields : ${\displaystyle r_{1,2}=\left({\frac {(1+r_{2})^{t_{2}}}{(1+r_{1})^{t_{1}}}}\right)^{\frac {1}{t_{2}-t_{1}}}-1}$

The discount factor formula for period (0, t) ${\displaystyle \Delta _{t}}$ expressed in years, and rate ${\displaystyle r_{t}}$ for this period being ${\displaystyle DF(0,t)={\frac {1}{(1+r_{t})^{\Delta _{t}}}}}$, the forward rate can be expressed in terms of discount factors:

${\displaystyle r_{1,2}={\bigg (}{\frac {DF(0,t_{1})}{DF(0,t_{2})}}{\bigg )}^{\frac {1}{t_{2}-t_{1}}}-1}$

### Continuously compounded rate

${\displaystyle e^{r_{1}t_{1}}e^{r_{1,2}(t_{2}-t_{1})}=e^{r_{2}t_{2}}}$

Solving for ${\displaystyle r_{1,2}}$ yields : ${\displaystyle r_{1,2}={\frac {r_{2}t_{2}-r_{1}t_{1}}{t_{2}-t_{1}}}}$

The discount factor formula for period (0, t) ${\displaystyle \Delta _{t}}$ expressed in years, and rate ${\displaystyle r_{t}}$ for this period being ${\displaystyle DF(0,t)=e^{-r_{t}\Delta _{t}}}$, the forward rate can be expressed in terms of discount factors:

${\displaystyle r_{1,2}={\frac {1}{t_{2}-t_{1}}}(\ln {DF(0,t_{1})}-\ln {DF(0,t_{2})})}$

${\displaystyle r_{1,2}}$ is the forward rate between time ${\displaystyle t_{1}}$ and time ${\displaystyle t_{2}}$,

${\displaystyle r_{k}}$ is the zero-coupon yield for the time period ${\displaystyle (0,t_{k})}$, (k=1, 2).