NPTEL

International Finance
Vinod Gupta School of Management , IIT. Kharagpur .

Module - 15
Exchange Rate Arithmetic:
Forward Rates

Developed by: Dr. Prabina Rajib

Associate Professor
Vinod Gupta School of Management
IIT Kharagpur, 721 302
Email: prabina@vgsom.iitkgp.ernet.in

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NPTEL
International Finance
Vinod Gupta School of Management , IIT. Kharagpur .

Lesson - 15
Exchange Rate Arithmetic: Forward Rates
Highlights & Motivation:
Banks/forex dealers offer bid-ask quotations for different currency pair in the spot as well
as in the forward market. Forward markets are quoted not only in standard periods of
1,2,3 and 6months, dealers also quote forward rates for non-standard periods. These are
known as broken period forward quotes. The relationship between the spot rate and
forward rates is measured by calculating Premium/Discount of forward rate vis--vis spot
rate. Forward rates are affected by many factors. One of the most important factor which
affect forward rate is the interest rate differential between currencies.

Learning Objectives:
Hence the objectives this module is to understand the following aspects:
Broken period forward rates using interpolation method.

Calculation of Premium/Discount on forward rates

Factors affecting forward rates.

Forward swap points.

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International Finance
Vinod Gupta School of Management , IIT. Kharagpur .

15.1: Introduction:
Forex dealers normally quote forward rates at regular intervals like one month or three
months. For example, dealers normally quote 1-week, 2-week, 1,2,3 6 months forward
rate. However, depending on customers requirement, these delaers quote forward rate on
a specific future date that is not an exact multiple of months. Such kinds of forwards
quotes are known as broken period quotes.
Banks normally quote broken period rates by method of interpolation. Let us take an
example to understand this.
On July 14th the following rates are quoted by a bank as given in Table 15.1. However a
corporate customer wants to buy 100,000 USD on October 21st. The bank has to quote a
forward rate for this date.

Table 15.1: Cash/Swap rates in points

USDINR
Spot

Maturity Date
July 14th

Bid Rate
47.0725

Ask Rate
47.0745

1 Month

August 14th

135

130

2 Month

September 14th

140

133

3 month

October 14th

160

145

4 months

November 14th

175

155

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International Finance
Vinod Gupta School of Management , IIT. Kharagpur .

The interpolation method is used as follows:

The forward rate points applicable are (160 to 175) for bid and (145-155) for ask.

For 31 days (October 14th to November 14th), the bid spread is 15 points (175 to
160).
15
For 7 days, the spread in bid point =
7 = 3.89 . So the spread applicable for
31
October 21st is 160 + 3.89 = 163.89

Similarly, for 31 days (October 14th to November 14th), the ask spread is 10 points
10
(155 to 145). For 7 days, the spread in bid point =
7 = 2.26 . So the spread
31
applicable for October 21st is 145 + 2.26 = 147.26

The applicable bid rate for 31 days (October 14th to November 14th), the ask
spread is 15 points (175 to 160). For 7 days, the spread in ask point
15
=
7 = 3.89 . So the ask spread applicable for October 21st is 160 + 2.26 =
31
163.89

So the applicable bid rate will be = 47.0725 - 0.014726 = 47.0577.

Ask spread is = 47.0745- 0.016389=47.0581.

Table 15.2: Interpolated Bid-Ask Spread ( USDINR)
Maturity Date
October 21st

Bid Rate
47.0576

Ask Rate
47.0581

For a forward contract maturing on October 21st, the bank would quote a rate (47.057647.0581) given in Table 15.2. As the company wants to buy USD 100,000, the bank will
offer USD at a rate of INR 47.0581. If the company would like to sell USD, then
applicable rate would be INR 47.0576.
As forward contracts are OTC contracts, in real life, most of the contracts would be for a
broken periods.

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International Finance
Vinod Gupta School of Management , IIT. Kharagpur .

15.3: Premium & Discount on Forward Quotations:

Forward quotations can be expressed as percentage premium or discount to the spot rate.
Table 15.3 details the forward quotations expressed as percentage premium/discount to
forward quotations.
Table 15.3 Forward Quotations in Outright and Percentage form
USDINR

Outright Quotations

Bid Rate
Spot
47.0725
1 week
47.0750
2 weeks
47.0795
1 month
47.0840
2 months
47.0900
(*) : Annualized premium/discount

Ask Rate
47.0745
47.0775
47.0835
47.0890
47.0965

USD
Percentage
Premium/Discount (*)
Bid Rate
Ask Rate
0.28%
0.40%
0.29%
0.22%

0.33%
0.52%
0.37%
0.28%

The forward rate (1 week) is expressed as a percentage premium/discount in relation to

spot in the following manner.
Compared to spot and 1 week forward, forward bid price of USD is more expensive by
0.0025.
n day forward bid spot bid
365
*
* 100
spot bid
n day forward rate
47.0750 47.0725 365
=
*
* 100 = 0.28%
47.0725
7

% Pr emium / Discount =

The above equation indicates that forward 1 week USD is at premium.

Similarly % premium/discount in forward ask rate (1 week) can be calculated in the
above manner by comparing 1 week ask rate with the spot ask rate.
As the forward rates (for different maturities) are higher than the spot rates, the forward
rates are at a premium. In other words, as USD is expected appreciate (as INR is
expected to depreciate), forward USD is at premium.
To find out the % premium/discount of INR, we need to find out the bid-ask spread with
INR as base currency. Table 15.4 lists the INRUSD bid-ask spread.

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International Finance
Vinod Gupta School of Management , IIT. Kharagpur .

Table 15.4 Forward Quotations in outright and percentage form

INRUSD

Outright Quotations

Spot
1 week
2 weeks
1month
2 months

Bid Rate
0.021243
0.021242
0.021239
0.021236
0.021233

Ask Rate
0.021244
0.021243
0.021241
0.021239
0.021236

INR
Percentage
Premium/Discount (*)
Bid Rate
Ask Rate
-0.25%
-0.49%
-0.40%
-0.28%

-0.25%
-0.37%
-0.28%
-0.23%

As the forward rates (for different maturities) are lesser than the spot rates, INR is
expected to depreciate as USD is expected to appreciate). Hence, forward INR is at
discount to USD.
To sum up, when forward quote/variable currency appreciates (depreciates), the
base currency is at discount (premium).

15.5 : Factors affecting forward rates.

By now, we are familiar with the intricacies of bid-ask quotations, broken period
quotation, forward rate premium/discount aspects. But how do the banks/dealers quote
these forward rates? What factors do they take into consideration for quoting a forward
rate.

Besides supply, demand factors, the most important factor which governs the forward
point quotation is the prevailing interest rates in two currencies.
D
I IB
Spot * v
*

100 360
Forward point =
D
I
1+ B *

100 360

Where: S = spot rate

IV = Interest rate in Variable/Quote/Term currency
IB = Interest rate in Base currency.
D= Actual No. of days between the spot and forward date.
360= No. of days in year. Different countries use different day count conventions. It can
also be 365.

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International Finance
Vinod Gupta School of Management , IIT. Kharagpur .

If the forward point is positive, it is added to the spot rate otherwise, it is subtracted form
the spot rate.
Let us take an example to understand this aspect: A bank wants to quote forward rate for
6 month from the spot date. The details are

S = Rs. 46.60/USD
IV = Interest rate in India is 8% per annum
IB = Interest rate in US is 4% per annum.
D= 182 days
360= No. of days in year.

D
I IB
Spot * v
*

100 360
Forward point =
D
I
1+ B *

100 360

8 4
46 . 60 *
*
100

Forward point =
182
4
1+
*
100 360

182
360
= 0.485= 48.5 points.

Forward point calculated in the above manner is also known as forward swap points.
Hence the 6-month forward rate would be = 46.60 +0.485= INR 47.085/ USD

Now suppose, the interest rate in India is 3% while in USA it is 5%. The forward point
would be calculated as
3 5 182
46 . 60 *
*
100 360

Forward point =
= -0.459= -45.9 points.
182
5
1+
*

100 360
Hence the 6-month forward rate would be = 46.60 - 0.459= INR 46.141/ USD

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International Finance
Vinod Gupta School of Management , IIT. Kharagpur .

MULTIPLE CHOICE QUESTIONS:

1. In a standard USDJPY quotations, the JPY pip value is
a. 0.01
b. 0.001
c. 0.001
d. 1.000
2. The spot USDINR bid and ask rate is given as 47.5123-47.5130. If the 3 monthbid-ask in points are 53-42, then what would be INRUSD 3 month rate in outright
quotations.
a.
b.
c.
d.

47.507-47.5088
0.02104-0.02105
0.02105-0.02104
None of these.

3. A depreciation of the INR refers to a (an):

a) Fall in the INR price of foreign currency
b) Increase in the INR price of foreign currency
c) Loss of foreign-exchange reserves for the India.
d) None of these
4. Suppose spot USD/INR is 46.75 ad 1 year US interest rate is 5% while it is 11%
in India. The 1 year USD/INR forward rate is
a. 42.22
b. 42.29
c. 49.42
d. None of these.
5. Suppose spot USD/INR is 46.75 and 1 year forward rate 47.66. The
_________ __________ of 1.967%
a. Appreciation, INR
b. Depreciation, INR
c. Appreciation, USD
d. Depreciation, USD
e. None of these.

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International Finance
Vinod Gupta School of Management , IIT. Kharagpur .

6. A bank is quoting spot rate INRUSD as 0.020942. Interest rate prevailing in USA
is 4.5% and in India is 10%. 1 year INRUSD forward swap points would be
_______ while, the 1 year INRUSD outright forward quotations would be
___________
a. -0.000280, 0.02066
b. +0.000280, 0.02122
c. -0.0045, 0.02017
d. None of these
7. If USDINR rate is 45.17 and USDJPY is 112.35, what would be JPYINR rate?
a.
b.
c.
d.

2.4872
0.0310
0.40204
32.217

8. Suppose RBI pursue a tight monetary policy. All else being equal, the impact of
this policy was to __________ interest rates in the India relative to those in USA and
cause the dollar to __________ against INR.
a. Decrease, depreciate
b. Decrease, appreciate
c. Increase, depreciate
d. Increase, appreciate
9. Given the following quotations (where the dollar is the home currency), what is the
annualized forward premium (discount) on the U.S. dollar?
Spot rate: $1.305/euro
6-month forward rate: $1.335/euro
a.
b.
c.
d.

premium; 4.4944%
premium; 4.5977%
discount; 4.4944%
discount; 4.5977%

10.
If the spot rate of the Deutsche mark is $.30 and the six month forward rate of the
mark is $.32, what is the forward premium or discount on an annual basis?
a) premium; about 14.5%
b) discount; about 14.5%
c) premium; about 13.3%.
d) discount; about 13.3%.
e) premium; about 16.7%.

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International Finance
Vinod Gupta School of Management , IIT. Kharagpur .

11.
If the spot rate of the Deutsche mark is $.32 and the six month forward rate is
$.30, what is the forward premium or discount on an annual basis?
a) discount; 11.5%.
b) premium; 11.5%.
c) premium; 12.5%.
d) discount; 12.5%.
e) premium; 22.5%.
12. The bid price is $0.64 for the German mark and the ask price is $0.68 for the German
mark. What is the bid-ask spread for the mark?
a) 6.77%
b) 7.77%
c) 8.75%
d) 6.25%
e) 5.25%

Short Questions:
1. Suppose USDJPY Spot rate is USD110.25/USD. How much is one pip for
100,000 JPY and how much one pip worth 100,000 USD?
2. The spot USDINR bid and ask rate is given as 47.6730-47.6754. If the 3 monthbid-ask in points are 55-65, then what would be INRUSD 3-month rate in outright
quotations. If the bid-ask points reverses i.e, 65-55, then would be INRUSD 3
month rate in outright quotations.
3. A Canadian Exporter exporting goods to USA will receive USD100,000 after 3
months. A bank quotes 3-month USDCAD forward bid ask rate as ( 1.2302
1.2315). How much the Canadian exporter will receive if he enters the forward
contract?
4. Spot rate USDINR is as follows: If the 3 month forward bid-ask point is 105-123,
then what will be the 3-month outright forward quotations? If the 3 month
forward bid-ask point is 123-105,what would be the outright forward quotations.
5. Suppose spot USD/INR is 46.75 and 1 year forward rate 47.66. Find out the %
appreciation/depreciation of USD as well as INR. Can you conclude that %
appreciation and depreciation will be same for both INR and USD?

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International Finance
Vinod Gupta School of Management , IIT. Kharagpur .

6. The following rates are given. If a bank wants to quote a forward rate to a
company wanting to take a forward cover on October 27th, what would be the bidask rate in outright form?
Cash/Swap rates in points
USDINR
Spot

Maturity Date
July 14th

Bid Rate
47.0725

Ask Rate
47.0745

3 month

October 14th

90

97

4 months

November 14th

100

109

7. Suppose spot USD/INR is 46.75 and 1 year US interest rate is 5% while it is 11%
in India. A bank is quoting 1 year forward rate as 43.35. Does this give rise
arbitrage opportunity? If so how a trader can benefit from this opportunity ?
8. A bank is quoting spot rate USD INR as 45.1560 Interest rate prevailing in USA
is 3.5% and in India is 9%. Calculate what would be the 1 year USDINR
forward swap points and what would be the 1 year USDINR outright forward
quotations?
9. Bank A is quoting USDINR rate is 45.1725 and JPYUSD 0.0089. Bank B is
quoting JPYINR rate of 0.4050. Find out the cross rate from Bank As point of
view and check whether any arbitrage opportunity exist or not? If exists, show
how the arbitrage profit can be made.

Answer to Multiple Choice Question:

1. (a)
2. ( b)
3. (b)
4. ( c)
5. ( c)
6. ( a)
7. (c )
8. ( a)
9. (d)
10. ( c)
11. (d )
12. (d)

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International Finance
Vinod Gupta School of Management , IIT. Kharagpur .

References:
1. Importance of Length of Quotation in foreign Exchange.
www.caclubindia.com/.../icici-fires-dealer-for-forex-fraud-26289.asp
2. Forex Quotations http://www.reuters.com/finance/currencies.
3. The foreign Exchange Market (Chapter 5), Fundamentals of Multinational
Finance, 3e (Moffett).

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