Page 50 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

Unit 3: Foreign Exchange Market and Exchange Rates

Forward Premiums and Discounts Notes

If the forward rate is higher than the existing Spot rate in the Forward Market, the Currency
is trading at a forward premium.

If the forward rate is lower than the existing Spot rate in the Forward Market, the Currency
is trading at a forward discount.
Forward rates typically differ from Spot rates for any given Currency, that reflects a premium or
discount on the Currency. Forward Premiums and discounts can be expressed as a basis point
spread. If the rupee Spot rate in terms of the dollar is ` 49.6172/$ and the 6 month forward rate
is 49.6141/$, then the rupee is selling at a 6 month forward discount of .0031 or 31 basis points.
A foreign exchange rate is generally expressed by way of a whole number integer followed by
4 decimal points like 0.0007. Each of the numbers is called a basis point. Thus, if an exchange rate
changes from 3.5510 to 3.5580, the Currency is said to have changed by 70 basis points.
Forward Premiums are also quoted as an annualized percentage deviation from the current Spot
rate. The formula for this calculation is

FR – SR
Premium/Discount = × 4 × 100
SR
Where n is the number of periods per year. For example, if the SR and FR are given for 90 days,
n = 4. Multiplying by 4 converts the periodic forward premium or discount into an annualized
rate. Similarly, a 6 month forward premium or discount is annualized by multiplying by 2;
a one month is multiplied by n = 12.
Problem 1:

Assume the following foreign exchange quotations are given for a 90 day contract. Calculate the
premium or discount on an annualized basis.
Solution:

SR= $ 0.8576/£
FR = $ 0.8500/£

.8500 – .8576
Forward Discount = × 4 × 100 = 3.54% p.a.
.8576
Problem 2:
For the following Spot and forward quotes, calculate forward Premiums/discount on Japanese
yen as (a) an annualized percentage premium.

Spot ($/*) Forward ($/*) Days Forward
0.009056355 0.008968508 30
0.009056355 0.008772955 90
0.009056355 0.008489201 180

0.009056355 0.007920280 360

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