Dear CFA candidates , can anyone help to understand what is the difference between forward rate and expected spot rate ? and what is the difference between forward price and expected spot price ? and is there any relation between the 2 (interest rates and price) ?
Forward prices are basically determined by using theorical framework by incorporating interest rates etc. However, due to factors such as supply and demand, the price you calculated would be different. Because, the price may be a function of inputs what you used to calculate PLUS expectations about the demand and supply. Hence, they may different at the terminal horizon.
I remember I had a hard time getting to grips with this last year. I back everything FRM2cfa said and add: The arbitrage free price (forward price) is acheivable in some markets, like the currency markets. Cash can easily be invested at the risk free rate and the relevant currency purchased and sold. Due to the structure of certain industries its difficulty to purchasing the underlying, like commodities. So unless you hold the underlying (EG: a broker) it becomes more difficult to earn a arbitrage free profit and hence expected spot rates can be used.