Forward Quotations

Forward rates can be expressed in two ways. Commercial customers are usually quoted the actual price, otherwise known as the outright rate. In the interbank market, however, dealers quote the forward rate only as a discount from, or a premium on, the spot rate. This forward differential is known as the swap rate. As explained in Chapter 4, a foreign currency is at a forward discount if the forward rate expressed in dollars is below the spot rate, whereas a forward premium exists if the forward rate is above the spot rate. As we see in the next section, the forward premium or discount is closely related to the difference in interest rates on the two currencies.

According to Exhibit 7.5, spot Japanese yen on May 19, 2008, sold at $0.009585, whereas 180-day forward yen were priced at $0.009673. Based on these rates, the swap rate for the 180-day forward yen was quoted as an 88-point premium (0.009673 − 0.009585), where a point, or “pip,” refers to the last digit quoted. Similarly, because the 90-day British pound was quoted at $1.9334, whereas the spot pound was $1.9479, the 90-day forward British pound sold at a 145-point discount.

Based on Equation 4.1, which is repeated here as Equation 7.1, the forward premium or discount on a foreign currency may also be expressed as an annualized percentage deviation from the spot rate using the following formula:

where the exchange rate is stated in domestic currency units per unit of foreign currency.

Thus, on May 19, 2008, the 180-day forward Japanese yen was selling at a 1.84% annualized premium:

The 90-day British pound was selling at a 2.98% annualized discount:

A swap rate can be converted into an outright rate by adding the premium (in points) to, or subtracting the discount (in points) from, the spot rate. Although the swap rates do not carry plus or minus signs, you can determine whether the forward rate is at a discount or a premium using the following rule: When the forward bid in points is smaller than the ask rate in points, the forward rate is at a premium and the points should be added to the spot price to compute the outright quote. Conversely, if the bid in points exceeds the ask in points, the forward rate is at a discount and the points must be subtracted from the spot price to get the outright quotes.7

Suppose the following quotes are received for spot, 30-day, 90-day, and 180-day Swiss francs (SFr) and pounds sterling: