What is a forward rate?

A forward rate refers to the agreed-upon exchange rate for a currency transaction that will occur at a specific future date. This concept is particularly relevant in foreign exchange markets, where parties can lock in rates to avoid fluctuations between the present and the future transaction date. Since currency values can be volatile, the forward rate serves as a financial tool for risk management, allowing businesses and investors to predict costs and revenues more reliably.

The value of the forward rate is determined based on the current spot rate and the different interest rates between the two currencies involved. Thus, it reflects market expectations about future currency movements rather than current market prices.

The other options do not capture the correct definition of a forward rate. The current exchange rate for immediate transactions refers to the spot rate. An average exchange rate used in accounting is not related to a specific future transaction. A fixed exchange rate for a year does not characterize the nature of a forward rate, which is about future transactions rather than a static rate for an extended period.