Forward points, forward premiums and discounts

What are forward points?

A forward exchange rate is the rate agreed today for exchanging currencies on a set future date. Dealers rarely quote it outright. They quote the spot rate and the gap between the forward and the spot, in forward points (also called swap points or pips).

The points are the forward rate minus the spot rate, scaled so that one point is one unit of the last decimal of the spot quote. Most pairs are quoted to four decimals, so a difference of 0.0001 is one point. The yen is quoted to two decimals, so a difference of 0.01 is one point.

To turn points into a forward rate, undo the scaling and add the result to spot.

$$F = S + \frac{\text{points}}{10{,}000} \qquad \left(\text{yen pairs: } \frac{\text{points}}{100}\right)$$

Forward points on an A/B quotepoints = (F − S), scaled to the last decimal of the spot quote

• Scale Memorize move the decimal point to the last digit of spot
  • Four-decimal pairs divide points by 10,000
  • Yen pairs (two decimals) divide points by 100
• Positive points: F is above S Memorize add them to spot
  • Base currency B at a forward premium
  • Price currency A at a forward discount
• Negative points: F is below S Memorize subtract them from spot
  • Base currency B at a forward discount
  • Price currency A at a forward premium
• What it signals Know the idea the interest rate gap, not a forecast

How do you read a forward premium or discount?

If the forward rate is above spot, the points are positive and the base currency is at a forward premium : a unit of it costs more for forward delivery. If the forward is below spot, the points are negative and the base currency is at a forward discount . The price currency has the opposite position.

The same gap can be stated as a percentage of spot.

$$\text{premium (discount)} = \frac{F}{S} - 1$$

Going the other way, a quoted percentage gives the forward rate directly.

$$F = S \times (1 + \text{premium})$$

Exam tip ”Premium” and “discount” in F ÷ S − 1 always describe the base currency of the quote. The price currency is in the opposite position.

What does a premium tell you?

Not where spot is going. The forward rate reflects the interest rate gap between the two currencies, which the next lesson derives. As a rule you can use now: the currency with the higher interest rate trades at a forward discount, and the one with the lower rate at a forward premium. A negative number of points on an A/B quote therefore tells you that the base currency B has the higher interest rate.

Why do points grow with maturity?

Know the idea

The number of points is roughly proportional to the interest rate gap times the time to maturity. Longer forwards carry more points, and a wider interest rate gap carries more as well. Here is a ladder for USD/GBP with spot 1.2700 (our own numbers).

Maturity	Points	Forward rate	Premium (discount) of GBP
1 week	−3.1	1.26969	−0.024%
1 month	−8.4	1.26916	−0.066%
3 months	−21.6	1.26784	−0.170%
6 months	−42.8	1.26572	−0.337%
12 months	−83.0	1.26170	−0.654%

Doubling the maturity roughly doubles the points, but not exactly. The next lesson shows why.

Go deeper Why dealers quote points

Know the idea

Spot moves all day, but the interest rate gap, and so the points, change slowly. Quoting points lets a dealer keep a forward price current with one small adjustment, and a client can see the forward cost of a hedge at a glance.

Go deeper FX swaps and swap points

Know the idea

A foreign exchange (FX) swap is a spot trade and an opposite forward trade done together. The price of the swap is the forward points, which is why they are also called swap points.