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Sem 5 Prep
← Open Economy MacroSpot, forward, swaps, futures and options

Formulas for this chapter

Forward discount or premium, annualised

FD or FP = ((FR - SR) / SR) x (12 / n) x 100

Any question giving a spot rate and a forward rate. Positive is a premium, negative a discount. The slide's 'x 4' is only the n = 3 case.

FR
Forward rate, in domestic currency per unit of foreign currency
SR
Spot rate, the same way round, and always the denominator
n
Maturity in months: factor is 12 for one month, 4 for three, 2 for six, 1 for twelve

Cost of forward cover

Cost of cover = amount x (FR - SR) as a % of the spot value = (FR - SR) / SR x 100

Comparing a forward contract with paying at today's spot rate. A premium makes cover a cost; a discount makes it a saving.

Amount
The foreign currency sum being covered
FR - SR
Positive means the hedger pays for certainty; negative means the hedger is paid for it

Swap rate

Swap rate = forward rate - spot rate

Pricing a currency swap, which is a spot sale plus a forward repurchase in one transaction. It is the same raw gap that the annualised premium or discount is built from.

Forward rate
The rate on the repurchase leg
Spot rate
The rate on the sale leg, settling within two business days
Step 2 of 25
The real wordsTheory

Spot and forward, defined

Spot ratethe exchange rate that calls for payment and receipt of the foreign exchange within two business days from the date the transaction was made.
Forward ratethe exchange rate that calls for delivery of the foreign exchange one, three, six, twelve or twenty-four months after the date the contract is signed.

Two business days is the examinable detail: "immediate" is not the definition. The forward maturities are a fixed menu, and the note adds one line worth remembering: the forward rate may be equal to, above, or below the spot rate.

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