What are Forward Rates?
A Forward Contract is an agreement between you and another party (i.e. the bank) to exchange foreign currency at a future date. This means you can fix an exchange rate for 6-12 months and protect yourself from any big currency movements.
What are Forward Points? When you buy a Forward Contract, the exchange rate available can deviate from the SPOT rate. This is determined by what the Forward rate will be when the contract is finished. You don’t need to know exactly how they work, but there are a few key things to know. These points (i.e. Forward Points) come in the form of basis points or pips, which are added to the SPOT rate when you buy the Forward Contract. This will make the rate you bought the Forward at higher than the SPOT rate.
A Pre-Covid Example In 2018, the Forward Points earned on a GBPUSD contract were around 1%. You decided to buy a Forward contract at 1.3050 for 12 months. The SPOT exchange rate at 1.3050 plus the points you earned would have meant your rate could have been 1.3180, had the broker not kept the points (more on that later).
How are Forward Points calculated? The Forward Points you earn depend on the Forward Contract you buy. Forward Points for GBPUSD are calculated by taking the difference between the Bank of England interest rate and the US Federal Reserve Bank interest rate. This applies to any currency pair and is the difference between the two interest rates of each country. Buying a currency with a higher interest rate using a currency with a lower interest rate means you earn positive points, making the rate you bought the Forward at higher than the SPOT rate. This is called a Forward Premium. However, buying a currency with a lower interest rate using a currency with a higher interest rate means you lose points. This is a Forward Discount.
Tip: it’s important to remember that you lose points when buying a currency with a lower interest rate, meaning the rate you buy the Forward at will be worse than the SPOT rate.
What do brokers usually do with my Forward Points? Typically, foreign exchange brokers will keep these points as additional revenue. If we use the Forward Points for GBPUSD in 2018 again, it means that if the broker took a 1% spread from the SPOT rate, they also earned an extra 1% from your points. For someone buying a £1,000,000 Forward Contract, this meant the broker made up to £20,000 on the transaction.
How do I earn my Forward Points? The ability to earn Forward Points with banks is usually reserved for large corporations. As far as we know, we are the only non-bank to offer our users the freedom to earn and keep their points. You can earn your points by signing up to Integritas Direct.