How are FX forward points determined, and what does it mean to say a currency trades at a forward premium or discount?
A core Corporate Treasury interview question — asked in analyst and associate interviews across IB, PE, and the Big 4.
THE SHORT ANSWER
Forward points come from covered interest rate parity, not a forecast of the spot rate: the forward rate adjusts spot for the interest-rate differential between the two currencies over the period, so that you can't arbitrage by borrowing in one currency, converting, investing in the other, and hedging back. The currency with the higher interest rate trades at a forward discount (it's cheaper forward), and the lower-rate currency trades at a forward premium. So forward points reflect the rate differential — they're a financing cost/benefit, not the market's view of where spot will go. Practically this is the 'carry' of a hedge: hedging a high-yield currency exposure forward gives up the rate pickup, while hedging a low-yield exposure can earn positive carry. A treasurer should understand that a forward is a financing-implied rate, which is why hedging cost is driven by interest differentials.
WHAT INTERVIEWERS LISTEN FOR
- ✓Forward = spot adjusted by interest-rate differential (covered parity)
- ✓Higher-rate currency at a forward discount; lower-rate at a premium
- ✓Forward points are a financing cost, not a spot forecast
- ✓Drives hedging carry cost/benefit
COMMON MISTAKES
- ✗Thinking forwards predict future spot
- ✗Reversing premium/discount logic
- ✗Ignoring that hedging cost = rate differential
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