Forward Premium and Discount in the Currency Market
Ascending means add, descending means subtract. Then four steps to the annualised premium, all by hand.
A forward rate is the exchange rate fixed today for delivery on a date after the spot date. It is rarely the same as the spot rate. When the foreign currency costs more for forward delivery than for spot, it is at a premium. When it costs less, it is at a discount. The difference between the forward rate and the spot rate is called the forward margin, or swap points.
This sits in Module IV, Forex Dealings, of the Certified Treasury Professional (CTP) syllabus, next to quotes, cover operations and open positions. Questions here are arithmetic, and the exam allows only a basic 8-function calculator. So the skill being tested is reading a quote correctly and doing three or four clean steps by hand.
You save ₹250
- Full-length mocks
- Chapter-wise practice
- Calculation practice
One payment, no subscription · Valid for 1 month
The Vocabulary of a Forex Quote
- Direct quote
- Home currency per unit of foreign currency, for example USD 1 = ₹80.0000. The quoting bank buys low and sells high.
- Indirect quote
- Foreign currency per unit (or per 100 units) of home currency, for example ₹100 = USD 1.2494/1.2500. The quoting bank buys high and sells low.
- Two-way quote
- A buying (bid) rate and a selling (ask or offer) rate together. The gap between them is the spread.
- Cash, TOM, spot
- Cash or ready settles the same day. TOM settles the next working day. Spot settles on the second working business day after the deal date.
- Forward
- Any delivery date beyond spot. Under FEDAI rules the duration of a forward contract is counted from the spot value date.
- Swap points
- Forward rate minus spot rate, quoted in points. One point is 0.0001, so 1200 points is ₹0.12.
Direct and Indirect: One Rate, Two Ways
Illustrative interbank quote: USD 1 = ₹80.0000/0400. The indirect version is 100 divided by each rate, with the order flipped.
Direct: USD 1 = ₹80.0000/80.0400
Bank buys USD at
₹80.0000 (lower figure)
Bank sells USD at
₹80.0400 (higher figure)
Rule
Buy low, sell high
Indirect: ₹100 = USD 1.2494/1.2500
Bank buys USD at
USD 1.2500 per ₹100 (higher figure)
Bank sells USD at
USD 1.2494 per ₹100 (lower figure)
Rule
Buy high, sell low
| Quote | Bank buys USD at | Bank sells USD at | Rule |
|---|---|---|---|
| Direct: USD 1 = ₹80.0000/80.0400 | ₹80.0000 (lower figure) | ₹80.0400 (higher figure) | Buy low, sell high |
| Indirect: ₹100 = USD 1.2494/1.2500 | USD 1.2500 per ₹100 (higher figure) | USD 1.2494 per ₹100 (lower figure) | Buy high, sell low |
Ascending Means Add, Descending Means Subtract
Forward margins are quoted as two figures in points, the first for buying and the second for selling, matching the spot quote. You never get told the word premium or discount. You read it from the order of the two figures.
If the first figure is smaller than the second (ascending, say 1200/1300), the foreign currency is at a premium and the points are added to spot. If the first is bigger (descending, say 2500/2300), it is at a discount and the points are deducted. The rule always widens the forward spread compared with spot, which is a quick check that you applied it the right way.
Worked Example: Outright Forward Rates
Illustrative. USD spot ₹80.0000/0400 with 1-month margin 1200/1300 and 3-month 3600/3800 (both ascending, so premium). A second currency, EUR, spot ₹90.0000/0500 with 1-month margin 2500/2300 (descending, so discount).
USD spot
Buying rate
₹80.0000
Selling rate
₹80.0400
Working
As quoted
USD 1 month (premium)
Buying rate
₹80.1200
Selling rate
₹80.1700
Working
80.0000 + 0.1200; 80.0400 + 0.1300
USD 3 months (premium)
Buying rate
₹80.3600
Selling rate
₹80.4200
Working
80.0000 + 0.3600; 80.0400 + 0.3800
EUR spot
Buying rate
₹90.0000
Selling rate
₹90.0500
Working
As quoted
EUR 1 month (discount)
Buying rate
₹89.7500
Selling rate
₹89.8200
Working
90.0000 minus 0.2500; 90.0500 minus 0.2300
| Delivery | Buying rate | Selling rate | Working |
|---|---|---|---|
| USD spot | ₹80.0000 | ₹80.0400 | As quoted |
| USD 1 month (premium) | ₹80.1200 | ₹80.1700 | 80.0000 + 0.1200; 80.0400 + 0.1300 |
| USD 3 months (premium) | ₹80.3600 | ₹80.4200 | 80.0000 + 0.3600; 80.0400 + 0.3800 |
| EUR spot | ₹90.0000 | ₹90.0500 | As quoted |
| EUR 1 month (discount) | ₹89.7500 | ₹89.8200 | 90.0000 minus 0.2500; 90.0500 minus 0.2300 |
Quote-reading sums in the real format. No signup.
Worked Example: Theoretical 6-Month Forward
Illustrative. Spot ₹80.00, rupee interest 7% a year, dollar interest 3% a year, six months (half a year, simple interest).
Rupee factor for 6 months
Working
1 + 0.07 x 6/12
Result
1.035
Dollar factor for 6 months
Working
1 + 0.03 x 6/12
Result
1.015
Forward rate
Working
80.00 x 1.035 / 1.015
Result
₹81.5764
Premium
Working
81.5764 minus 80.00
Result
₹1.5764 (15764 points)
Annualised premium
Working
1.5764 / 80 x 12/6 x 100
Result
About 3.94%
Shortcut check
Working
Spot x rate gap x time = 80 x 4% x 0.5
Result
₹1.60, close to the exact figure
| Step | Working | Result |
|---|---|---|
| Rupee factor for 6 months | 1 + 0.07 x 6/12 | 1.035 |
| Dollar factor for 6 months | 1 + 0.03 x 6/12 | 1.015 |
| Forward rate | 80.00 x 1.035 / 1.015 | ₹81.5764 |
| Premium | 81.5764 minus 80.00 | ₹1.5764 (15764 points) |
| Annualised premium | 1.5764 / 80 x 12/6 x 100 | About 3.94% |
| Shortcut check | Spot x rate gap x time = 80 x 4% x 0.5 | ₹1.60, close to the exact figure |
Merchant Deals and Cover Operations
When an exporter sells dollars forward to its bank, the bank now holds a long dollar forward position. A cover operation is the bank's opposite deal in the interbank market that squares that position. Illustration: an exporter expecting USD 1,00,000 in three months books a forward sale with the bank. The bank's rate to the customer sits below the interbank buying rate by its margin, say ₹80.30. The bank then sells USD 1,00,000 three months forward in the interbank market at ₹80.36, which brings in ₹80,36,000 against ₹80,30,000 paid to the exporter. The exporter's rupee amount is fixed whatever the spot rate does in three months, and the bank's position is square.
Positions the bank does not cover are open positions, and RBI makes each bank's Board set limits on them. RBI's Master Direction on risk management and inter-bank dealings measures the open position in each currency as net spot plus net forward plus net options. Across currencies, the overall position is the higher of total longs or total shorts (the shorthand method).
The Two Limits That Cap Open Positions
From Annex I of RBI's Master Direction on Risk Management and Inter-Bank Dealings. Each bank's Board fixes its own figure within RBI's ceiling.
Net Overnight Open Position Limit (NOOPL)
What it controls
The overall overnight open position across currencies, which attracts capital charge
RBI ceiling
Not above 25% of total capital (Tier I plus Tier II)
Aggregate Gap Limit (AGL)
What it controls
Mismatches between forward maturities across time buckets
RBI ceiling
Not above 6 times total capital; banks using tenor-wise PV01 and VaR limits may use those instead
| Limit | What it controls | RBI ceiling |
|---|---|---|
| Net Overnight Open Position Limit (NOOPL) | The overall overnight open position across currencies, which attracts capital charge | Not above 25% of total capital (Tier I plus Tier II) |
| Aggregate Gap Limit (AGL) | Mismatches between forward maturities across time buckets | Not above 6 times total capital; banks using tenor-wise PV01 and VaR limits may use those instead |
How the CTP Exam Tests This
- check_circleReading the order: given 3600/3800 or 2500/2300, decide premium or discount before doing any sum. Most wrong answers apply the points the wrong way.
- check_circlePoints to rupees: 3600 points is ₹0.3600, not ₹3.60 or ₹0.036.
- check_circleAnnualising: the premium over the period, divided by spot, times 12 over the months. Watch for days (use 365) in the question.
- check_circleParity direction: the higher-interest currency is at a forward discount. Questions often give two interest rates and ask which currency is at a premium.
- check_circleQuote side: in a direct quote the bank buys at the lower figure; in an indirect quote it buys at the higher figure.
- check_circleLimits: NOOP and gap limits are set by the Board within RBI ceilings, and NOOP is the one that attracts capital charge.
FAQs
How do you know if a forward rate is at a premium or a discount?expand_more
Look at the order of the swap points. Ascending (first figure smaller, like 1200/1300) is a premium and is added to spot. Descending (like 2500/2300) is a discount and is subtracted.
What is the formula for annualised forward premium?expand_more
For the currency quoted per unit: (forward minus spot) / spot x 100 x 12 / number of months. If the period is in days, use 365 / days instead of 12 / months.
What are swap points?expand_more
The forward rate minus the spot rate, quoted in points of 0.0001. They are also called the forward margin.
Why is the higher-interest currency at a forward discount?expand_more
Covered interest rate parity. If the forward rate did not offset the interest gap, a dealer could borrow the cheap currency, invest in the dear one, cover with a forward and earn a riskless profit.
Can I use a financial calculator in the CTP exam?expand_more
No. IIBF allows a battery-operated calculator with up to 8 functions and 12 digits. Scientific and financial calculators are not allowed, so practise these sums by hand.
Access exam-specific mock tests directly from your Android device.Next steps
- Bond Pricing & Durationarrow_forward
- Swaps & FRAsarrow_forward
- Syllabusarrow_forward
- Preparationarrow_forward
100 questions on the full CTP syllabus, timed and scored.