Table of Contents
- What Are Forward Points?
- Key Takeaways
- Understanding Forward Points
- Important Note on Forwards vs. Swaps
- Discount Spreads
- Important Note for Traders
- Examples of Forward Points
- What Do Swap Points Tell You?
- What Is the Difference Between a Swap and a Forward?
- How Do You Calculate the Forward Rate of a Bond?
- The Bottom Line
What Are Forward Points?
Let me explain forward points directly: in currency trading, they're the number of basis points you add to or subtract from the current spot rate of a currency pair to figure out the forward rate for delivery on a specific date. If you're adding points to the spot rate, that's a forward premium; subtracting them means a forward discount.
The forward rate comes from the interest rate difference between the two currencies involved—remember, every currency deal involves a pair—and the time until the deal matures. You might also hear forward points called the forward spread.
Basis points can go either way from the spot rate. Adding them gives you forward points, while subtracting creates discount points.
Key Takeaways
To sum it up, forward points in currency trading are those basis points added or subtracted from the spot rate to determine the forward rate for a set delivery date.
A discount spread involves subtracting currency forward points from the spot rate to get the forward rate.
Adding points to the spot rate creates a forward premium; subtracting them results in a forward discount.
Understanding Forward Points
You use forward points to calculate prices for outright forward contracts and foreign currency swaps. You can calculate points and execute transactions for any valid business day in both currencies. The most traded forward currencies include the U.S. dollar, euro, Japanese yen, British pound, and Swiss franc.
Forwards typically cover periods up to one year, though you can get prices for longer dates with lower liquidity. In an outright forward contract, you buy one currency against another for delivery beyond the spot date. The price is the spot rate plus or minus the forward points up to the value date, and no money exchanges until then.
In a foreign exchange swap, you buy a currency for the near date—usually spot—against another, then sell the same amount back on the forward date. The forward leg rate is the near-date rate plus or minus forward points to the far date, with money changing hands on both dates.
Important Note on Forwards vs. Swaps
Keep this straight: a forward contract differs from a swap. In a forward, you agree to exchange an asset at a future date; in a swap, you exchange the interest rates from those assets.
Discount Spreads
Unlike the forward spread, a discount spread subtracts currency forward points from the spot rate to get the forward rate. In currency markets, forward spreads or points come as two-way quotes with bid and offer prices. For a discount spread, the bid price exceeds the offer; for a premium spread, the bid is lower than the offer.
Important Note for Traders
As a currency trader, you aim to profit from interest payment differences in the currencies you hold.
Examples of Forward Points
Forward points often appear as numbers like +13.2 or -270.68, representing 1/10,000—so +13.2 means 0.00132 added to the spot price.
For instance, if you can buy the euro against the dollar at 1.1350 spot, and forward points are +13.2, the forward rate becomes 1.13632 (that's 1.1350 + 0.00132).
From this, you see the U.S. interest rate is higher than in the Eurozone. Positive forward points when buying EUR/USD mean the rate increases further into the future, compensating for interest rate differences.
Put another way, with a 1% euro interest rate and 2% U.S. rate, you could gain 1% by holding dollars over euros. This factors into future exchange rates via forwards.
What Do Swap Points Tell You?
Swap points show the expected interest rate on a currency swap. Positive points mean you earn interest on the sold currency; negative ones mean you owe interest.
What Is the Difference Between a Swap and a Forward?
Both forwards and swaps are derivatives based on an underlying asset's price. The key difference: a forward requires delivering the asset later, while a swap only transfers interest payments from it.
How Do You Calculate the Forward Rate of a Bond?
The forward rate for a bond uses spot rate differences for bonds of varying maturities. Calculate it by dividing the longer-term bond's interest rate by the shorter-term one's, then subtract one.
The Bottom Line
Forward points, or swap points, measure the gap between a currency pair's current spot price and its price at maturity. Adding them means you expect to earn interest; subtracting means you expect to pay it.
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