Forward price
Forward price (aka forward rate) is a predefined price of an underlying asset within a forward contract.
A forward contract is an agreement between two parties that establishes that both of the parties are planning to conduct the sale and purchase of a predetermined amount of the underlying asset, for a specific price (forward price), at a specific moment in the future. The underlying asset can be a currency, any commodity or any other financial asset.
Most commonly forward contracts are used by commodities traders (for example, producers of grain) with the purpose of locking in profit and hedging against extreme price fluctuations.
Because the trade takes place in the future, the forward price has to take into account a set of aspects that could impact the price of the commodity in the future, like interest rate, inflation, climate nuances (like drought) and other aspects.
Calculating forward price
The forward price is calculated using the following formula:
F=S0*erT
It assumes that the dividends amount to 0. In the formula:
F – Forward price
S0 – Current spot price of the underlying asset
e – The mathematical irrational constant approximated by 2.7183
r – The risk-free rate that applies to the life of the forward contract (in years)
T – Time to maturity (in years).
