FX Forwards and Forward Points
An FX forward fixes an exchange rate for a future date. Learn how forward rates and forward points are calculated from interest rates, with examples and uses.
An FX forward is an agreement to exchange one currency for another at a fixed rate on a specific future date. Companies use forwards to lock in the cost of future payments or the value of future receipts; investors use them to hedge foreign assets. The forward rate is not a forecast of where the exchange rate will be. It is set by today's spot rate and the interest rate difference between the two currencies, expressed through forward points.
Forward rate formula#
Covered interest parity links spot, forward and interest rates:
forward = spot × (1 + r_quote × T) / (1 + r_base × T)- spot: current exchange rate (quote currency per unit of base)
- r_quote, r_base: interest rates of the quote and base currencies
- T: time in years (using each currency's day count convention in practice)
The currency with the higher interest rate trades at a forward discount; the one with the lower rate trades at a forward premium. See Covered and Uncovered Interest Parity.
Forward points#
Dealers quote the difference between forward and spot as forward points, in pips:
forward points = (forward - spot) × 10,000 (or × 100 for yen pairs)Why forwards reflect rates#
If the forward rate did not reflect the interest difference, there would be an arbitrage. In the example, an investor could borrow dollars at 5%, convert to euros at spot, invest at 3% and lock in the conversion back to dollars with a forward. If the forward were too high, this would produce a riskless profit; trading on it would push the forward back in line. This covered interest arbitrage keeps forwards close to parity, apart from the small deviation known as the cross currency basis. See Cross-Currency Basis.
Reading forward quotes#
Dealers quote forward points as bid and offer, for example "205 / 210". The convention:
- If the first number is smaller than the second, points are added to spot (forward premium).
- If the first is larger, points are subtracted (forward discount).
Uses of FX forwards#
| User | Use |
|---|---|
| Importers | Lock in the cost of foreign currency payments |
| Exporters | Lock in the value of foreign currency receipts |
| Investors | Hedge the currency risk of foreign stocks and bonds |
| Treasurers | Manage cash flows across subsidiaries |
| Speculators | Take currency views without spot settlement |
Forwards, swaps and futures#
- FX swap: a spot trade combined with an opposite forward trade, used for funding and rolling positions. See FX Swaps and Currency Swaps.
- Currency futures: standardised exchange traded forwards with daily settlement. See Currency Futures and Forwards vs Futures.
- Non deliverable forwards: cash settled forwards for restricted currencies. See Non-Deliverable Forwards (NDFs).
Common mistakes#
- Treating the forward rate as a forecast.
- Ignoring hedging costs when foreign rates exceed domestic rates.
- Mixing up premium and discount in forward point quotes.
Frequently asked questions#
What is an FX forward?#
An agreement to exchange currencies at a fixed rate on a specific future date.
How are forward points calculated?#
From the spot rate and the interest rate difference between the two currencies: forward points equal the forward rate minus spot, expressed in pips.
Is the forward rate a prediction of the future exchange rate?#
No. It mainly reflects today's spot rate and the interest rate difference between the two currencies.
Next, learn about forwards for restricted currencies in Non-Deliverable Forwards (NDFs).
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Mentioned in
- FX LiquidityForex
- Currency FuturesForex
- Cross-Currency BasisForex
- HedgingMarkets and Instruments
- Time Value of MoneyMath and Statistics