Hong Life CalculatorsUnderstanding the forward premium calculator — concept and principle
This calculator finds the forward premium or discount on a currency from the spot and forward exchange rates, annualizes it, and compares the market forward with the forward implied by covered interest parity using the two interest rates. It also shows the forward points and the interest-rate differential. Use it in international finance courses, for currency hedging and to check FX forward quotes.
How it is calculated
With rates quoted as your currency per unit of foreign currency:
- Forward premium = (forward − spot) ÷ spot.
- Annualized = premium × (days in year ÷ days to delivery).
- Forward points = forward − spot.
- Parity forward F = S × (1 + i_home × d ÷ basis) ÷ (1 + i_foreign × d ÷ basis).
- Market minus parity forward shows any deviation.
A positive premium means the foreign currency costs more for later delivery.
The principle
Covered interest parity says you cannot earn a riskless profit by borrowing in one currency, converting, investing in the other and locking in the conversion back with a forward. For that to hold, the forward rate must offset the interest-rate difference. So the currency with the lower interest rate trades at a forward premium, roughly equal to the rate gap. Small deviations remain in practice because of transaction costs and limits on bank balance sheets.
Worked example
Default inputs: spot 1.10, forward 1.115, 180 days, home rate 5%, foreign rate 2.25%, 360-day basis.
- Premium = (1.115 − 1.10) ÷ 1.10 ≈ 1.36%; forward points 0.015.
- Annualized = 1.36% × 360 ÷ 180 ≈ 2.73%.
- Parity forward = 1.10 × (1 + 0.05 × 0.5) ÷ (1 + 0.0225 × 0.5) = 1.10 × 1.025 ÷ 1.01125 ≈ 1.115.
- Market minus parity forward ≈ 0.
- Interest differential = 2.75 points a year; the foreign currency trades at a forward premium.
| Spot rate (your currency per 1 unit of foreign currency) | Forward premium (+) or discount (−) |
|---|---|
| 0.275 | 305.45% |
| 0.55 | 102.73% |
| 0.825 | 35.15% |
| 1.1 | 1.36% |
| 1.38 | -18.91% |
| 1.65 | -32.42% |
| 2.2 | -49.32% |
How to read the result
If the annualized premium is close to the interest differential, the forward is consistent with parity. A large gap would suggest a quote error, unusual market stress or costs not captured here. For a hedger, the premium is the cost (or benefit) of locking in the rate today.
Common mistakes
- Quoting rates the other way round (foreign per home currency), which flips the sign.
- Using the wrong day-count basis for a currency's money market.
- Treating the forward rate as a forecast of the future spot rate.
- Annualizing very short periods without care.
Frequently asked questions
Is a forward premium a prediction that the currency will rise?
No. It mainly reflects the interest-rate difference, not a forecast.
What is covered interest parity?
The no-arbitrage relation linking spot and forward rates to the two interest rates.
Which currency trades at a forward premium?
The one with the lower interest rate.
Sources: Federal Reserve Bank of New York, Current Issues in Economics and Finance, vol. 15, no. 6 (October 2009), appendix "Measuring the Foreign Exchange Basis"