Forward margin
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The document discusses forward rates, forward margins, and how to calculate them. Some key points: - The forward margin is the difference between the forward rate and spot rate, and can be at a premium or discount. - If at a premium, the foreign currency is more expensive forward than spot. If at a discount, it is cheaper forward than spot. - To get the forward rate from the spot rate, you either add the premium or subtract the discount. - An example calculation of a forward margin using interest rate differentials and time periods is provided.
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2) Theories explaining the shape of the yield curve such as expectations theory and liquidity preference theory.
3) How the yield curve can provide insights into economic conditions and expectations of future interest rates and inflation.
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Derivatives markets in interest rate & foreign exchange rate
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Forward margin
- 1. A.Sai Kumar
- 2. The difference between the forward rate and the spot rate is known as the ‘forward margin’ or swap points Commodity or currency spot price today minus the price on a set future date.
- 3. The forward margin may be either at ‘premium’ or at ‘discount’. If the forward margin is at premium, the foreign currency will be costlier under forward rate than under the spot rate. If the forward margin is at discount, the foreign currency will be cheaper for forward delivery then for spot deliver
- 4. Under direct quotation, premium is added to spot rate to arrive at the forward rate. This is done for both purchase and sale transactions. Discount is deducted from the spot rate to arrive at the forward rate.
- 5. Interpretation of Interbank quotations The market quotation for a currency consists of the spot rate and the forward margin. The outright forward rate has to be calculated by loading the forward margin into the spot rate. For instance, US dollar is quoted as under in the interbank market on 25th January as under: Spot USD 1 = ` 48.4000/48.4200 Spot/February 2000/2100 Spot/March 3500/3600
- 6. Where the forward margin for a month is given in ascending order as in the quotation above, it indicates that the forward currency is at premium. The outright forward rates arrived at by adding the forward margin to the spot rates
- 7. If the forward currency is at discount, it would be indicated by quoting the forward margin in the descending order. Suppose that on 20th April, the quotation for pound sterling in the interbank market is as follows: Spot GBR 1 = ` 73.4000/4300 Spot/May 3800/3600 Spot/June 5700/5400 Since the forward margin is in descending order (3800/3600), forward sterling is at discount. The outright forward rates are calculated by deducting the related discount from the spot rate. Thus is shown b
- 8. From the above calculations the outright rates for pound sterling cab be restated as follows; Buying Selling Spot GBR 1 = ` 73.4000 73.4300 Forward delivery May 73.0200 73.0700 Forward delivery June 72.8300 72.8900
- 9. Calculation of Forward Margin Example The forward margin can be calculated for a specific period given the spot rate and interest differential. Let the spot rate and interest rate differential are as follows: Spot rate $1=Deutschmark 1.5000 and the interest rate differential is equal to 8 per cent(US 3.5% and DEM 11.5%).Let us also assume that the no. of days in a year to be 360 days and the forward margin is for a period of 180 days or 6 months. The forward margin therefore is
- 10. Forward margin = Forward period X Interest Differential X spot rate 100x No. of days in the year = 180 X 8 X 1.5000 100X360 The Forward margin for 180 days = 0.0600. The forward rate is obtained by adding the forward margin to spot rate. Forward rate is equal to Spot rate plus or minus forward margin.
- 11. Rate of Interest Demand and Supply: Speculation about Spot Rates: Exchange Regulations: