# Implied Rate Explained: How to Calculate and Use It With Examples

## What Is the Implied Rate?

The implied rate represents the difference between the [spot rate](https://www.investopedia.com/terms/s/spot_rate.asp) of an asset and its forward or futures rate, serving as a critical measure for comparing potential investment returns. It applies to a variety of securities and helps in evaluating the risk and return characteristics of options or futures contracts.

### Key Takeaways

*   The implied rate is calculated by comparing the spot rate with the forward or futures rate of a security.
*   Investors use the implied rate to evaluate and compare investment returns and risks.
*   The calculation involves taking the ratio of the forward price to the spot price, then adjusting for the contract duration.
*   Implied rates can be derived for various securities, including commodities, stocks, and currencies.
*   A positive implied rate suggests that future borrowing rates may be higher than current rates.

## Breaking Down the Implied Rate Mechanism

The implied interest rate gives investors a way to compare returns across investments and evaluate the risk and return characteristics of that particular security. An implied interest rate can be calculated for any type of security that also has an [option](https://www.investopedia.com/terms/o/optionscontract.asp) or [futures contract](https://www.investopedia.com/terms/f/futurescontract.asp).

For example, if the current U.S. dollar deposit rate is 1% for spot and 1.5% in one year, the implied rate is 0.5%. Alternatively, if a currency's spot price is 1.050 and the futures price is 1.1071, the implied rate is 5.71%. In both of these examples, the implied rate is positive, which indicates that the market expects future borrowing rates to be higher than they are now.

To calculate the implied rate, divide the forward price by the spot price, raise the result to the power of 1 divided by the contract length, then subtract 1.

*   Implied rate = (forward / spot) raised to the power of (1 / time) - 1

where time is the length of the forward contract in years

## Practical Examples of Implied Rate Calculation

### Commodities

If the [spot price](https://www.investopedia.com/terms/s/spotprice.asp) for a barrel of oil is $68 and a one-year futures contract for a barrel of oil is $71, the implied interest rate is:

Implied rate = (71/68) -1 = 4.41%

Divide the futures price of $71 by the spot price of $68. For a one-year contract, raise this ratio to the power of 1, subtract 1, and find the implied rate of 4.41%.

### Stocks

If a [stock](https://www.investopedia.com/terms/s/stock.asp) is currently trading at $30 and there is a two-year [forward contract](https://www.investopedia.com/terms/f/forwardcontract.asp) trading at $39, the implied interest rate is:

Implied rate = (39/30) - 1 = 14.02%

Divide the forward price of $39 by the spot price of $30. For a two-year contract, raise the ratio to the power of 1/2, subtract 1, and you get an implied rate of 14.02%.

### Currencies

If the spot rate for the [euro](https://www.investopedia.com/terms/e/euro.asp) is $1.2291 and the one-year futures price for the euro is $1.2655, the implied interest rate is:

Implied rate = (1.2655 / 1.2291) - 1 = 2.96%

Divide 1.2655 by 1.2291 to find the ratio. For a one-year contract, raise it to the power of 1, subtract 1, and the implied rate is 2.96%.

## The Bottom Line

The implied rate serves as a vital tool for investors, offering a method to compare returns and evaluate the risk and return profile across various securities. By understanding and calculating the implied rate, investors can make informed predictions about future interest rates based on current spot and forward rates.

This calculation is applicable to any security with an associated option or futures contract, whether it be in commodities, stocks, or currencies. Implied rates help in gauging market expectations of future borrowing costs, empowering investors to make strategic financial decisions.