There are many examples in the literature, not all of them the same, but a collection of models estimated by researchers at the Federal Reserve illustrates their potential to shed light on the behavior of long-term forward rates
The dollar discount on the three-month forward rate
of exchange is 0.
Finally, if we model forward rates
as log-normal processes the HJM model will explode (2).
In contrast, changes in longer-term expectations of policy that influence distant forward rates
are more likely to reflect investors' changing views of structural features of the economy, including long-run policy objectives.
The loss on the forward contract, based on the change in forward rates
during the period (0.
For example, an options dealer might hedge all of the six-month forward rates
of between three and five years in terms of a single exposure to the three-to-five-year forward interest rate.
as Predictors of Future Spot Rates, Journal of Financial Economics, 3: 361-377.
7) By using Jensen's Inequality, we show that forward rates
cannot be expected to be unbiased estimators of corresponding future spot rates for both buyers and sellers of the same forward currency contracts.
This unique linear combination is known as the 'cointegrating equation' or the 'cointegrating vector', and can be thought of as a long-run equilibrium relationship that forces spot and forward rates
to move together.
For the purpose of this study however, we concentrate only on those variables involved in interest rate parity theory, such as forward rates
, spot rates, and domestic and foreign interest rates.
Compare the annualized all-in cost of each bond issue assuming exchange rate risk for the Eurobond issues is hedged using the forward rates
provided by Zeutsche Bank.
Increases in these forward rates
are thought two be governed largely by future increases in the real interest rate or future increases in inflation.