This will reflect my lack of knowledge with reference to Spot and Forward trading rate components…
In summary, what components make up the Spot rate and Forward rates when there is a transaction for each of those. So in other words, I would just like some clarification on the details behind what / how many legs there are, what makes up the rate (margin etc?)
Thinking about it like a deal confirmation email where you see the rate you have got form your broker…what if you could get absolute transparency from your broker on the breakdown of the rates / legs etc? what else would you want to see on the deal confirmation email with reference to the spot and forward deals?
So for clarity spot being a simple buy/sell currency and forward being well a forwards contract (a customized contract between two parties to buy or sell an asset at a specified price on a future date)
Many thanks in advance
Greetings. I do not and have never traded forward contracts myself but the forward rate for a currency transaction is usually calculated as the current spot multiplied by the interest rate difference between each currency.
The formula is:
F = Forward Rate
S = Spot Rate
rf = foreign currency interest rate
rd = domestic currency interest rate
That should give the intrinsic value minus transaction costs. rf and rd would be the interest rates for the period being considered, so if you had an annual interest rate and wanted to work out the 3 month forward rate then you would have to adjust the values, similarly for the other way around.
rf refers to the interest rate for the first currency in the pair and rd the interest rate for the second
You can use simple formula to calculate forward rate from spot rates and vice versa:
1+(1-year forward rate) = (1+2-year spot rate)^2/1+(1-year spot rate)
In equilibrium investors are indifferent between depositing straight for 2 years at 2-year spot rate or deposit for one year and then deposit again at 1 year forward rate.
