Forward Points

Forward points (also called forward spread or swap points) are the basis-point adjustment added to or subtracted from a currency pair’s spot rate to determine the forward rate for a specified value date. When points are added to the spot rate it is a forward premium; when points are subtracted it is a forward discount. Forward points reflect the interest-rate differential between the two currencies and the time to maturity.

Key takeaways

• Forward points convert a spot quote into a forward quote for a given value date.
• Positive points (premium) raise the forward rate above spot; negative points (discount) lower it.
• They reflect the interest-rate difference between the two currencies and the term of the transaction.
• Forward points are used in outright forward contracts and in the forward leg of FX swaps.

How forward points are used

• Quoting: Forward points are usually quoted in pips or basis points (often shown as parts of 1/10,000).
• Outright forward: One currency is bought against another for delivery on a future date. The forward rate = spot rate ± forward points. No exchange of principal occurs until the value date.
• FX swap: In a swap, one currency is bought for the near leg (often spot) and sold for the far leg. The forward leg’s rate equals the near rate ± forward points. Cash changes hands on both value dates.
• Term and liquidity: Forwards are commonly traded up to one year; longer-dated forwards are available but generally less liquid.

Discount vs premium spreads and quoting conventions

• Discount spread: Forward points subtracted from the spot to get the forward rate.
• Premium spread: Forward points added to the spot to get the forward rate.
• Two-way quotes: Forward points are presented with bid and offer values. In a discount spread the bid forward points may be higher than the offer; in a premium spread the bid may be lower than the offer.
• Economic reason: Forward points compensate for the interest-rate differential between the two currencies—traders account for the relative yields of the currencies they hold.

Example

If EUR/USD spot = 1.1350 and forward points = +13.2 (quoted as pips), interpret as:
* Convert points: +13.2 pips = +0.00132
* Forward rate = 1.1350 + 0.00132 = 1.13632

A positive forward adjustment here implies the forward rate is higher than spot, reflecting the relevant interest-rate differential (in this example, higher U.S. interest rates relative to the Eurozone).

What swap points tell you

Swap points are the forward points used in FX swaps. They indicate the interest-rate differential embodied in the forward leg:
* Positive swap points → forward rate > spot (forward premium).
* Negative swap points → forward rate < spot (forward discount).
They do not directly state which party earns interest; they show how the market prices the interest differential between the two currencies for the given term.

Forward rate for bonds (brief)

The implied forward rate between two maturities can be derived from spot yields. A common expression for the forward rate between times T1 and T2 is:
f = [(1 + R2)^(T2) / (1 + R1)^(T1)]^(1/(T2 − T1)) − 1
where R1 and R2 are the spot yields for maturities T1 and T2. This gives the rate that is consistent with current spot yields and the no-arbitrage condition.

Conclusion

Forward points are a simple numeric adjustment that translate spot FX rates into forward rates and encapsulate the interest-rate differential and term structure between two currencies. They are essential for pricing forwards, structuring swaps, and managing currency exposure.