How is the FX forward exchange rate calculated

The forward rate is calculated in a way that will not allow riskless profit (arbitrage) which results from the taking out of a loan denominated in a currency that requires a low-interest rate and depositing it in a deposit in another currency that yields a higher interest rate.

The risk inherent in the operation described lies in the exchange rate. If the currency in which the deposit was depreciated against the currency in which the loan was taken, then not only can the excess return be eliminated but the investor may suffer a considerable loss.

Technically, the FX forward pricing formula looks like this:

• r minor is the interest in the minor currency for the relevant period (days)

• r major is the interest in the major currency for the relevant period (days)

The interest rates used for calculating are not central bank interest, but inter-bank interest and the swap curve. Access to quality market information on interest rates is not easy, and in fact quality information usually costs money. However, here you will find up-to-date forward rates and forward points of leading currency pairs.

Forward Transactions: Chance / Risk Structure

Buy Forward Major currency / Minor currency

• Obligation to buy the major currency and sell the minor currency, at the forward strike, at the expiry date and at the notional amount (usually denominated in major currency terms). 

• Who is the product for? - For companies that are exposed to the appreciation of the major currency relative to the minor currency (Ex. EUR/USD going up).

Sell Forward Major currency / Minor currency

• Obligation to Sell the major currency and buy the minor currency, at the forward strike, at the expiry date and at the notional amount (usually denominated in major currency terms). 

• Who is the product for? - For companies that are exposed to the depreciation of the major currency relative to the minor currency (Ex. EUR/USD going down).

Payout chart

For currency pair: EUR/USD, Notional amount: 1 million EUR

• But forward payout in minor currency terms = (Rate at expiry - Forward strike) Notional amount in major currency terms

• Sell forward payout in minor currency terms = (Forward strike - Rate at expiry) Notional amount in major currency terms 

The forward transaction is admittedly the most popular, but it may only be so because it is simple. However, companies that have above-average financial knowledge, choose to hedge their currency exposures through option-based transactions. In this way they produce for themselves deals that are tailored to their unique needs, such as protecting budget rates, limiting loss potential, and there are many other reasons.

When it comes to option-based hedging deals, the variety of hedging strategies is huge. At the following link, you will find instructional videos of option-based hedging transactions, which are considered relatively popular (cylinder strategy, extra forward, etc.)

FX Forward points and rates table structure example

Here you will find up-to-date forward rates and forward points for leading currency pairs

See FX Forward point table and FX forward rates for different  currency pairs and dates:

EUR/USD FX Forward points

EUR/GBP FX Forward points

EUR/JPY FX Forward points

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