How Forward Rates are Quoted by Traders

Although spot rates are quoted in absolute terms say, x yen per dollar forward rates, as a matter of convenience are quoted among dealers in differentials that is, in premiums or discounts from the spot rate. The premium or discount is measured in “points,” which represent the interest rate differential between the two currencies for the period of the forward, converted into foreign exchange.
Specifically, points are the amount of foreign exchange (or basis points) that will neutralize the interest rate differential between two currencies for the applicable period. Thus, if interest rates are higher for currency A than currency B, the points will be the number of basis points to subtract from currency A’s spot exchange rate to yield a forward exchange rate that neutralizes or offsets the interest rate differential (see Box 5-2). Most forward contracts are arranged so that, at the outset, the present value of the contract is zero.

Traders in the market thus know that for any currency pair, if the base currency earns a higher interest rate than the terms currency, the base currency will trade at a forward discount,or below the spot rate; and if the base currency earns a lower interest rate than the terms currency, the base currency will trade at a forward premium, or above the spot rate.


Whichever side of the transaction the trader is on, the trader won’t gain (or lose) from both the interest rate differential and the forward premium/discount. A trader who loses on the interest rate will earn the forward premium, and viceversa.


Traders have long used rules of thumb and shortcuts for calculating whether to add or subtract the points.
Points are subtracted from the spot rate when the interest rate of the base currency is the higher one, since the base currency should trade at a forward discount; points are added when the interest rate of the base currency is the lower one, since the base currency should trade at a forward premium.Another rule of thumb is that the points must be added when the small number comes first in the quote of the differential, but subtracted when the larger number comes first.


For example,the spot CHF might be quoted at “1.5020- 30,” and the 3-month forward at “40-60” (to be added) or “60-40” (to be subtracted). Also, the spread will always grow larger when shifting from the spot quote to the forward quote. Screens now show positive and negative signs in front of points,making the process easier still.