- What is a forward rate?
The N-day forward rate
is the rate which appears in a
contract to exchange a currency for another N days in the future.
It is distinguished from
the spot rate, which is the rate used in agreements to
exchange one currency for another immediately. No currency
changes hand between the parties in a forward contract at the
time it is signed; the currency is exchanged at the maturity
date of the contract N days in the future.
- What is a forward premium (forward discount)?
A forward premium (forward discount) is the proportion by
which a country's forward exchange rate exceeds (falls below)
its spot rate.
- What are the determinants of the forward premium?
The forward premium (or forward discount if the number is negative)
is determined by the interest rate differential between the United
States and Canada. According to the Interest Rate Parity theorem,
the expected appreciation of the Canadian Dollar is equal to
the difference between the U.S. and Canadian interest rate.
For example, if the interest rate in Canada is one percent higher
than in the United States, over a period of one year the Canadian
Dollar will tend to depreciate by one percent. Note that a raise
in Canadian interest rates first lifts the exchange rate, and only
then the CAD starts to depreciate. The interest rate differential
is based on comparable assets (with risk premia already factored
in), for example, Canadian and U.S. 90-day or 1-year treasury bills.
- Is the forward rate a good predictor of the future spot rate?
No. For example, the relationship between today's 90-day forward
rate and the spot rate three months from now is very weak. It is not
even a good predictor of the direction, if not the magnitude, of the
expected change. Thus a forward rate cannot be used to predict
future exchange rates.
- What is the forward rate used for?
Insurance against exchange rate risk can be obtained through
contracts in the forward market. Such activity is called hedging.
A hedge is the offset of a given position in a separate bu parallel
market by an equal and opposite position in which the effect of
the offset reduces or eliminates the effects of a value change
in both positions. In simple terms, a hedge locks in the current value
in a contract. The instrument for a hedge is often a currency swap
in which a spot contract is offset by an equal-amount forward contract.
- Where can I get forward rate data?
The PACIFIC Exchange Rate Service publishes
daily CAD/USD forward rates. In Canada,
such data can be obtained from Statistics Canada, the Bank of
Canada, and other commercial providers. For forward rates of other
currencies please refer to commercial data providers are Bloomberg Financial Markets and
- Where can I learn more about forward rates, hedging, etc?