Lesson 5 of 6 · All lessons in this module
  1. Building a cross-rate from two quotesVideo lesson
  2. Triangular arbitrage and reading currency moves
  3. Forward points, premiums and discounts
  4. The no-arbitrage link between spot, forward and interest ratesVideo lesson
  5. Forward points, maturity and the rate differential
  6. Integrated cases: hedging a receivable and comparing dealers

Lesson 5 of 6 · 13 min

Forward points, maturity and the rate differential

For horizons shorter than the rate period, forward points equal spot times the interest rate differential scaled by the fraction of the year, so they are proportional to the differential and almost proportional to maturity.

In short

  • For a horizon that is a fraction τ of a year, interest earned is rτr \tau; for money-market rates, τ = actual days ÷ 360.
  • Forward rate: F=S1+rfτ1+rdτF = S\frac{1 + r_f \tau}{1 + r_d \tau}. Forward points: F−S=S(rf−rd)τ1+rdτF - S = S\frac{(r_f - r_d)\tau}{1 + r_d \tau}.
  • Points are proportional to the spot rate and to the rate differential: double the differential, double the points.
  • Points are only approximately proportional to maturity, because τ also appears in the denominator.
  • The four variables (spot, forward, the two rates) plus maturity are tied together; any one can be found from the others.

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