What is the premium forward?

Front premium is the difference between the current exchange rate of the currency and the rate used in the currency exchange stores. Theoretically, this may indicate how the market is expected to move the exchange rate in the future. There is also a theory that forward premium is associated with the difference between interest rates in two countries in question.

There are two types of exchange rates on the currency markets. The spot rate is the current average rate for which traders exchange currencies. The forward rate is the rate at which traders agree to exchange currencies in the future. Depending on what is the driving to this date, one of the traders in the store will come forward. This is because they will be able to take advantage of the differences between the exchange rate they use to complete the agreement and the rate they can then obtain for cash in the open market.

The front rate is always given in terms of specific duration. For example, the 12 -month transfer rate will be intended for forward monetary stores that will be completed in 12 months. The difference between today'sThe spot rate and the premium rate for a certain period of time is called the premium in advance. It is stated as a percentage and may be either a positive or negative number. If the number is negative, which means that the transfer rate is lower than the spot rate, the difference is usually referred to as a forward discount.

Premium forward should indicate how the market is expected to move currency rates. Given that the transfer rate is decided by several offers for exchange of currency forward, it is actually the average forecast of individual traders. In fact, human error, market confidence and unpredictability of events mean that there is often little relationship between rates used in forward shops and spot rates when these Come shops to complete.

Theory known as the parity of interest rates claims that there is a consistent relationship between the premium forward and the difference in interest rates available to investors in two countries whose currencies form a relevant exchange rate. The logic of this theoryIE is that whenever this relationship is distorted, distortion will affect the most profitable tactics in which the country will invest and whether to exchange currencies now or through a forward contract. The way investors respond to this should disrupt the market back to its original position, which should be a parity of interest rate self -repairing.