What are 'Forward Points'
Forward points are the number of basis points (bps) added to or subtracted from the current spot rate of a currency to determine the forward rate for delivery on a specific value date. When points are added to the spot rate, this is called a forward premium; when points are subtracted from the spot rate, the currency trades at a forward discount. The spot exchange rate is adjusted based on the difference between the interest rates of the two currency and the time until the maturity of the deal, which yields the forward rate.
BREAKING DOWN 'Forward Points'Forward points are used to calculate the price for both an outright forward contract and a foreign exchange swap. Points can be calculated and transactions executed for any date that is a valid business day in both currencies. The most commonly traded forward currencies are the U.S. dollar, the euro, Japanese yen, British pound and Swiss franc.
Forwards are most commonly done for periods of up to one year; prices for longer dates are available, but liquidity is generally far lower.
Forward points for a given date are quoted as a bid and offer, such as 11/13. If the offer (right) side is larger than the bid (left) side, the points are added to the spot rate. If the offer is lower than the bid, the points are subtracted.
For example, if euro can be bought vs. the dollar at the rate of 1.1350 for spot, and the forward points on the offer side for a given date are +13, the outright forward rate is 1.1363. By market convention, the last whole number in the quoted forward points lines up with the last digit of the price as it is conventionally quoted. Since the euro is quoted to four decimals vs. the dollar, working from right to left, the 13 is added to the 50.
In an outright forward foreign exchange contract, one currency is bought against another for delivery on any date beyond spot. The price is the spot rate plus or minus the forward points to the value date. No money changes hands until the value date.
Foreign Exchange Swap
In a foreign exchange swap, a currency is bought for the near date (usually spot) against another currency, and the same amount is sold back for the forward date. The rate for the forward leg of the swap is the near date rate plus or minus the forward points to the far date. Money changes hands on both value dates.