Forward points are the number of basis points (or pips) added to or subtracted from the current spot rate of a currency pair to determine the forward rate for delivery on a specific future date.
They reflect the interest rate differential between two currencies and are used in foreign exchange markets to calculate the price for both outright forward contracts and currency swaps.
The primary factor influencing forward points is the difference in interest rates between the two currencies involved, with other factors such as contract duration and market volatility also playing a role. Forward points help traders and firms hedge currency risk and anticipate future exchange rate movements.
Example:
Suppose a Canadian importer expects to pay €100,000 to a European supplier in three months and wants to lock in the exchange rate. The current spot rate is 1.4500 CAD/EUR. The bank quotes three-month forward points as +25.
Step 1: Convert Forward Points to Spot Rate Format
Forward points are typically quoted in “pips,” where one pip is 1/10,000 of the spot rate for most currency pairs (except those involving the Japanese yen).
To convert forward points to the spot rate format, divide the quoted points by 10,000:
25/10,000 = 0.0025
Step 2: Calculate the Forward Rate
Add the converted forward points to the spot rate to get the forward rate:
Forward rate = Spot rate + Converted forward points
Forward rate = 1.4500 + 0.0025 = 1.4525 CAD/EUR