What is an implied fee?
An implied rate is the interest rate that represents the difference between the forward rate and the spot rate associated with a specific investment. Typically, this particular interest rate is calculated by subtracting the current or spot rate from the forward or futures rate. The implied rate value can provide the investor with valuable clues as to the advantages or disadvantages of entering into a futures contract associated with that particular security or commodity.
To understand how the implicit rate works, it is necessary to know what is meant by spot rate and forward rate. Essentially, the spot rate is the interest rate that will remain in effect for the next few trading days. The forward or futures rate is the interest rate that will be applied to the bond on a specific date during the next few months. Depending on the nature of the investment, the amount of difference between these two fees may indicate that there is a significant benefit in completing the transaction now rather than agreeing to a settlement date in the future.
An example is to consider the London Interbank Offered Rate (LIBOR) which is offered with a specific investment. If the current LIBOR rate is set to seven percent and the future LIBOR rate is nine percent, that means the implied rate is two percent. This calculation tells the investor that borrowing will be slightly more expensive in the future and may lead the investor to enter into a transaction that settles while the current rate is still in effect, rather than opting for some sort of futures or forward contract. On the other hand, if the current rate is higher than the forward rate, this indicates that opting for a futures contract may allow the investor to lock in the commodity at a better rate later, while maintaining that better rate here and now.
Taking the time to calculate the implied rate can help investors get into what looks like big deals today but would actually cost more in the long run. In addition to considering factors such as future demand for the security or product and the general direction of the market, knowing the implied rate provides valuable clues as to when to execute the transaction and maximize potential returns. Since very little effort is required to determine the implied rate, it is possible for dealers and brokers, as well as investors, to quickly assess the investment's potential and determine whether the security or commodity is suitable for general investment objectives. for the investment portfolio.