Definition
Forward Premium / Discount
A currency trades at a forward premium when its forward rate is higher than spot, and at a discount when lower, driven mainly by the interest rate gap between the two countries.
For USDINR, the dollar trades at a forward premium because rupee interest rates exceed dollar rates. The premium, often expressed as an annualised percentage, tells you how much more rupees you pay to buy a dollar for forward delivery versus today.
The forward premium roughly equals the difference between Indian money-market rates (linked to the repo rate) and US rates. When the RBI hikes rates or US yields fall, the premium widens; when the gap narrows, premiums shrink, which matters for exporters deciding whether hedging is worth the cost.
Related terms
- Spot vs Forward Exchange RateThe spot rate is the price for settling a currency trade in the next two business days, while the forward rate is the agreed price today for delivery on a future date.
- USDINRUSDINR is the exchange rate of the US dollar against the Indian rupee, the most-watched currency pair in India and a key barometer of capital flows and import costs.
- Covered Interest Rate ParityCovered interest rate parity holds that the forward exchange rate must offset the interest rate gap between two currencies, otherwise risk-free arbitrage would be possible.
- Repo RateThe repo rate is the interest rate at which the RBI lends short-term money to commercial banks, and it is the central bank's main tool to balance inflation and growth.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.