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The forward curve is a
function graph In mathematics, the graph of a function f is the set of ordered pairs (x, y), where f(x) = y. In the common case where x and f(x) are real numbers, these pairs are Cartesian coordinates of points in two-dimensional space and thus form a subset ...
in
finance Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of fina ...
that defines the prices at which a contract for future delivery or payment can be concluded today. For example, a futures contract forward curve is prices being plotted as a function of the amount of time between now and the expiry date of the futures contract (with the
spot price In finance, a spot contract, spot transaction, or simply spot, is a contract of buying or selling a commodity, security or currency for immediate settlement (payment and delivery) on the spot date, which is normally two business days after t ...
being the price at time zero). The forward curve represents a term structure of prices.


Forward interest rate

A forward interest rate is a type of
interest rate An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, th ...
that is specified for a loan that will occur at a specified future date. As with current interest rates, forward interest rates include a term structure which shows the different forward rates offered to loans of different maturities. According to the unbiased expectations hypothesis, forward interest rates predict spot interest rates at the time the loan is actually made, but many analysts dispute whether this is true, as it ignores durational risk. This figure is part of the lending & credit industry and is related as well to the " expectations theory" which states that forward interest rates can be used as forecasts for future interest rates. Investors expecting higher short-term interest rates are more likely to buy bonds maturing in the short term. If they were to park money into a long term debt they might not be able to make as much interest. Finance analysts can refer to a graph of forward interest rate values over different time periods, the forward curve, to evaluate the
time value of money The time value of money is the widely accepted conjecture that there is greater benefit to receiving a sum of money now rather than an identical sum later. It may be seen as an implication of the later-developed concept of time preference. The t ...
.


Price forward curve

A Price forward curve (short ''PFC'') reflects specialties of the
commodity market A commodity market is a market that trades in the primary economic sector rather than manufactured products, such as cocoa, fruit and sugar. Hard commodities are mined, such as gold and oil. Futures contracts are the oldest way of investing ...
such as: * Transporting commodities is costly and time-consuming. * It is costly to store commodities -
power Power most often refers to: * Power (physics), meaning "rate of doing work" ** Engine power, the power put out by an engine ** Electric power * Power (social and political), the ability to influence people or events ** Abusive power Power may ...
storage is often prohibitively expensive. * Many commodities show a strong
seasonality In time series data, seasonality is the presence of variations that occur at specific regular intervals less than a year, such as weekly, monthly, or quarterly. Seasonality may be caused by various factors, such as weather, vacation, and holidays a ...
, e.g. there is more
natural gas Natural gas (also called fossil gas or simply gas) is a naturally occurring mixture of gaseous hydrocarbons consisting primarily of methane in addition to various smaller amounts of other higher alkanes. Low levels of trace gases like carbon di ...
demanded (for heating) in winter than in summer. In order to fairly value and manage the profitability of energy products it is thus necessary to capture these seasonal price dynamics in a forward curve term-structure. The contract duration of a
futures contract In finance, a futures contract (sometimes called a futures) is a standardized legal contract to buy or sell something at a predetermined price for delivery at a specified time in the future, between parties not yet known to each other. The asset ...
is limited by definition and
investor An investor is a person who allocates financial capital with the expectation of a future return (profit) or to gain an advantage (interest). Through this allocated capital most of the time the investor purchases some species of property. Typ ...
s have to change their contract during the contract term. Price forward curves help to determine when to do that, two scenarios are possible: # If the PFC is ascending, i.e. future commodity-contracts will be more expensive than at the moment, this is called
contango Contango is a situation where the futures price (or forward price) of a commodity is higher than the ''expected'' spot price of the contract at maturity. In a contango situation, arbitrageurs or speculators are "willing to pay more owfor a comm ...
. The investor will have additional costs as they have to sell their futures to a lower price than what they have to invest for their new futures. # If the PFC is descending, it is a so-called
backwardation Normal backwardation, also sometimes called backwardation, is the market condition where the price of a commodity's forward or futures contract is trading below the ''expected'' spot price at contract maturity. The resulting futures or forward ...
and investors will make money by exchanging (''rolling'') their old
futures contract In finance, a futures contract (sometimes called a futures) is a standardized legal contract to buy or sell something at a predetermined price for delivery at a specified time in the future, between parties not yet known to each other. The asset ...
s to new ones.


Hourly price forward curve

An hourly price forward curve (HPFC) is the construction of a forward curve at a resolution exceeding that known to the market and is as such able to capture the seasonalities of the electricity spot prices. The construction of an HPFC can be based on the combination of two approaches. A statistical approach examines how spot prices have moved in the past. A fundamental model suggests that the price is set purely by supply and demand (respectively, fuel prices on the merit order curve, and load).


References


Further reading

*Floyd, Jhon. E. (ed.): ''Interest Rates, Exchange Rates and World Monetary Policy'', Springer; 1 edition (December 17, 2009). {{ISBN, 978-3-642-10279-0. *
Forward interest rate
' at the free dictionary *
Unbiased Expectations Hypothesis
' at the free dictionary Electricity economics Interest rates Heath–Jarrow–Morton framework