Forward Prices

The FX forward market is an interest rate market. It is not about the value of one currency against another, but about the interest rate of one currency in comparison to another over a period. Forward traders are therefore interest rate traders, and as such, some banks include FX forward traders under their interest rate division rather than their FX division.

Forward traders do not trade FX rates, but FX forward points. Forward points represent the interest rate differential between two currencies from one value date to another value date.

Forward points are equivalent to pips in the spot market. Rather than being part of the spot rate, forward points are an adjustment to the spot rate to reflect the interest rate differential. Because forward points represent a difference in rate as opposed to being a rate, there is no big figure. For example, to represent a difference in EUR/USD between 1.0323 and 1.03275, the forward points would be 4.50, because one pip or point is worth 0.0001 in EUR/USD.

Forward points may be positive or negative and are usually quoted to an accuracy of hundredths (two decimal places) of one point. If they are positive, then the interest rate of CCY1 is lower than that of CCY2. If they are negative, then the interest rate of CCY1 is higher than that of CCY2. Unlike spot prices, the two sides of a forward price are not usually called “bid and offer”, but “left-hand-side” (LHS) and “right-hand-side” (RHS). The LHS is always less than the RHS, even if the forward points are negative.

Forward trade types

The rate for an FX forward trade (also known as a “forward outright”, “outright forward” or simply an “outright”) is calculated by adding the spot rate and the forward points together. Therefore, an outright is a combination of spot risk and forward risk, and such a trade needs to be priced by both the spot and the forward desks. Outrights are not traded interbank but are very popular with corporate customers who have a business need to settle an FX trade on an exact value date in the future.

The trades that the interbank FX forward market uses are FX swaps, not to be confused with interest rate swaps or interest rate derivatives. An FX swap is so-named because it swaps one currency for another over a given period. The market risk is the interest rate differential over that period. A swap is two legs in one trade in that there are two value dates and two sets of cashflows. The two legs of a swap are based on the same spot rate, but differ by the forward points. Therefore, there is no spot risk (except for swap differential). It is possible to trade “mismatched”, “uneven” or “non-round” swaps whereby the amounts vary on each leg of the swap. These types of swaps may carry spot risk. The leg of a swap with the first value date is known as the near leg, whereas the leg of a swap with the second value date is known as the far leg. Unlike a spot or outright trade, a swap trade is either a “buy and sell” or a “sell and buy”. It is the action on the far date that is significant to the pricing in that the bank buys on the LHS and sells on the RHS, similarly to spot. Most swaps have at least one leg on the spot date. Where both the near and far legs are after the spot date, it is called a “forward-forward swap” or a “forward swap”.

Unlike the interbank spot market, in the interbank forward market, every currency is quoted always against USD (except for some Balkan currencies which are traded against EUR). This can be complicated when calculating an outright rate, for example DKK/SEK. While the spot trader calculates a spot DKK/SEK rate using EUR/DKK and EUR/SEK, the forward trader calculates DKK/SEK forward points using USD/DKK and USD/SEK. The resulting DKK/SEK forward points can be added to the DKK/SEK spot rate to produce a DKK/SEK outright rate.

To calculate a cross-rate swap can be even more complicated. For example, to calculate a CHF/JPY swap, a forward trader must calculate each leg of the swap by triangulating USD/CHF and USD/JPY outright rates. The CHF/JPY spot rate is then subtracted from the resultant CHF/JPY outright rates to give CHF/JPY forward points. In practice, traders use tools and spreadsheets to speed up this process and reduce the scope for error.

Because interbank forward points are always quoted against USD, it is impossible to calculate accurate forward points for any cross currency for settlement on a USD holiday, e.g. 4th July. Although 4th July or any other USD holiday could never be a standard tenor date (including spot) for this reason, it is possible to settle a non-USD currency pair (e.g. EUR/GBP) on 4th July as a broken date but the spread would be very wide.

D2 supports limited currency pairs and tenors, and this is the extent of electronic broking for forward traders. In practice, only the most popular tenors in EUR/USD are traded via D2. Other currency pairs and tenors are traded via voice brokers or the direct interbank market. Therefore, in order to supply prices to a pricing engine, banks’ forward traders contribute prices, often using spreadsheets. This is feasible because, being interest rate based, the forward market is much less volatile than the spot market and latency is not a signficant issue.

Displaying Forward Prices

The following tables demonstrate, for a forward outright or swap, which side of the forward points is added to which side of the spot price. This is determined by whether each value date is before or after the spot date as well as whether a swap is matched (aka even, round) or mismatched (aka uneven, non-round). In the case of matched/mismatched, when comparing the near amount and far amount of a swap, it is important to use net present values, not the notional amounts. This table is particularly useful as a reference for e-commerce systems where a customer is shown a two-sided price, as the relevant sides of the price can be highlighted in different colours to clarify to the customer how the all-in rates are calculated. The action (buy, sell, S&B, B&S) is therefore shown here from a customer's point of view.

Forward outrights

Post-spot		Bid/LHS	Offer/RHS
Spot rate	Spot date	Sell	Buy
Forward	>Spot date	Sell	Buy

Pre-spot		Bid/LHS	Offer/RHS
Spot rate	Spot date	Sell	Buy
Forward	<Spot date	Buy	Sell

Post-spot swaps

Near amount >= Far amount		Bid/LHS	Offer/RHS
Spot rate	Spot date	S&B	B&S
Near points (optional)	>Spot date	S&B	B&S
Far points	>Spot date	B&S	S&B

Near amount < Far amount		Bid/LHS	Offer/RHS
Spot rate	Spot date	B&S	S&B
Near points (optional)	>Spot date	S&B	B&S
Far points	>Spot date	B&S	S&B

Pre-spot swaps (e.g. tom-next)

Near amount >= Far amount		Bid/LHS	Offer/RHS
Spot rate	Spot date	S&B	B&S
Near points	<Spot date	B&S	S&B
Far points (optional)	Any date	B&S	S&B

Near amount < Far amount		Bid/LHS	Offer/RHS
Spot rate	Spot date	B&S	S&B
Near points	<Spot date	B&S	S&B
Far points (optional)	Any date	B&S	S&B