DEFINITION of Discount Spread
A discount spread is the currency forward points that are subtracted from the spot rate, to obtain a forward rate for a currency. In the currency markets, forward spreads, or points, are presented as two-way quotes; that is, they have a bid price and an offer price. In a discount spread, the bid price will be higher than the offer price, while in a premium spread, the bid price will be lower than the offer price.
Forward points are used to arrive at the prices for both an outright forward contract and for a foreign currency swap. Forwards are most commonly done for periods of up to one year. Prices for further out dates are available, but liquidity is generally lower.
A discount spread may also refer to a forward currency trade situation in which the bid price is higher than the offer (ask) price. This implies that it is cheaper to buy the spread than to sell it, so that it is trading at a discount.
BREAKING DOWN Discount Spread
Forward points are typically quoted numberically, such as +15.5 points, or minus -32.68 points. Each point represents 1/10,000, so +15.5 points means 0.00155when added to a currency spot price. So, if the Swiss Franc can be bought versus the U.S. Dollar at the rate of 1.2550 for spot, and the forward points are +15.5, the forward rate is 1.25655 (or 1.2550 + 0.00155). Since points were added, this would constitute a premium spread.
Example of a Discount Spread
As an example of a discount spread, points would be deducted from the spot price. For instance, assume a Euro spot rate of EUR 1 = 1.4000 / 1.4002 USD, and that six-month interest rates for the euro are higher than for the USD. If the discount spread for six months is 25 / 24, the six-month euro rate will be EUR 1 = 1.3975 / 1.3978 (1.4000 - 0.0025 and 1.4002 - 0.0024).
As another example, taking the Swiss Franc and U.S Dollar, if the spot rate is 1.2550 and the forward points are minus -32.68, the forward rate will be quoted at a discount: 1.2550 - 0.003268 = 1.251732.
Finally, as an example of a discount spread where the bid is higher than the offer, a forward currency trade may be quoted as USD/CAD 1.30/1.29. Notice that the bid is greater than the offer in this case, which is unusual and causes it to be classified as a discount spread.