Last updated: May 15, 2024

Forward Premium Calculator

Q: What is hedging?

Hedging is a form of risk management where the party eliminates the risks of huge losses at the expense of reducing some potential profits . Hedging is typically carried out by commodity producers such as crude oil companies.

Q: What is foreign currency exposure?

Foreign currency exposure happens when a company has operations in other countries . For example, if a US-based company acquires a UK-based company and continues operating in the UK, the combined entity will have foreign currency exposure.

Q: What is speculating?

Speculating is a form of earning profit by buying a financial instrument and hoping to sell it at a higher price in the future . Speculating also includes shorting financial instruments if one thinks the price will drop in the future. All in all, speculating is a dangerous way to trade by timing the market.

Q: What is arbitrage?

Arbitrage is a way of earning risk-free profit by exploiting the mispricing of securities in different markets . This involves buying the instrument in one market and immediately selling it at a higher price in another market.

Q: What is the annualized forward premium for a 5% 180-day forward?

The annualized forward premium will be 10% . You can calculate it by using this formula: annualized forward premium = forward premium × (360 / days) = 5% × (360/180) = 10%

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Wei Bin Loo

A strategy consultant graduated from Imperial College London with abundant experience advising companies on analytics strategy and transformation projects. Having passed his CFA Level 2 with his results ranked above the 90th percentile, he possesses a broad expertise in the finance and investment space. He is also passionate about product management and is currently a Certified Scrum Product Owner (CSPO). He is a Harry Potter fanatic and a chess and basketball enthusiast. See full profile

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Tibor Pál

PhD candidate

Tibor is pursuing a Ph.D. in Statistical Methods in Economics at the University of Salerno. His main research activity is developing econometric models applied in macroeconomics with a primary focus on the interrelationship between finance and the real economy. His professional experience includes working as a general ledger (GL) accountant and a financial analyst. At Omni, he translates financial queries and regulations into calculators through JS coding with clear and user-friendly content. He spends the academic year in Italy but is keen to travel to Hungary, Poland, and Malaysia in his free time. Interested in gastronomy and vinery, he is able to feed the whole team with pörkölt - a delicious dish from his homeland. See full profile

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Table of contents

What is forward premium?How to calculate forward premium and annualized forward premium — Forward premium formula How to interpret the currency forward premium FAQs

With this forward premium calculator, you can easily calculate the forward premium and the annualized forward premium. This metric can help you analyze the future currency exchange rate trend. Please feel free to check out our forward rate calculator and risk calculator to understand more about this topic.

This article will help you understand what the forward premium is and how to calculate it using the forward premium formula. We will also demonstrate some calculation examples to help you understand the concept.

What is forward premium?

Before discussing the forward premium, we need to understand what currency forward is.

Currency forward is an agreement between two parties that allows you to buy or sell currency at a fixed exchange rate in the future. Furthermore, currency forwards do not require you to pay an upfront payment before entering the agreement. It also allows the parties to tailor the terms to suit their needs. It is usually used to hedge currency risks.

The currency forward premium is often defined as the difference between the spot and forward rate. The forward premium can also be seen as a situation when the forward rate is higher than the spot rate. On the other hand, when the forward rate is lower than the current spot rate, the situation is described as the forward discount.

How to calculate forward premium and annualized forward premium — Forward premium formula

Now, we can discuss the calculation of currency forward price. Let's take the currency forward of the GBP/EUR as an example. GBP stands for the British pound sterling, and the EUR stands for Euro.

Currency forward: GBP/EUR;
Number of days in the forward contract: 90 days;
Spot rate: 1.1859; and
Forward rate: 1.1885.

The calculation of the annualized currency forward premium requires four steps:

Determine the spot rate.

The spot rate is the current currency exchange rate of the currency pair. You can find this information by simply Googling it. To understand more about currency exchange rates, please check out our cross exchange rate calculator.

The spot rate of GBP/EUR is 1.1859.
Determine the forward rate.

The forward rate is the currency exchange rate on the forward contract. The forward rate of the GBP/EUR is 1.1885.
Calculate the forward premium.

The forward premium can be calculated using the forward premium formula below:

forward premium = (forward rate − spot rate) / spot rate

The forward premium for GBP/EUR is (1.1885 − 1.1859) / 1.1859 = 0.22%.
Calculate the annualized forward premium.

The annualized forward premium is the annual equivalent of the forward premium. We can calculate the metric using the formula below:

annualized forward premium = forward premium × (360 / days)

The annualized forward premium is 0.88%. Please use our day counter to speed up the calculation of the number of days in the forward contract.

How to interpret the currency forward premium

Interpreting the currency forward premium is easy. There are two situations that we need to look at：

When the forward rate is higher than the current spot rate, the situation is described as the forward premium. This means that the market expects the future spot rate to be higher than the current spot rate.
When the forward rate is lower than the current spot rate, the situation is described as the forward discount. This means that the market expects the future spot rate to be lower than the current spot rate.

FAQs

What is hedging?

Hedging is a form of risk management where the party eliminates the risks of huge losses at the expense of reducing some potential profits. Hedging is typically carried out by commodity producers such as crude oil companies.

What is foreign currency exposure?

Foreign currency exposure happens when a company has operations in other countries. For example, if a US-based company acquires a UK-based company and continues operating in the UK, the combined entity will have foreign currency exposure.

What is speculating?

Speculating is a form of earning profit by buying a financial instrument and hoping to sell it at a higher price in the future. Speculating also includes shorting financial instruments if one thinks the price will drop in the future. All in all, speculating is a dangerous way to trade by timing the market.

What is arbitrage?

Arbitrage is a way of earning risk-free profit by exploiting the mispricing of securities in different markets. This involves buying the instrument in one market and immediately selling it at a higher price in another market.

How can I calculate the forward premium?

You can calculate the forward premium in three steps:

Determine the spot rate.
Calculate the forward rate.
Apply the forward premium formula:

forward premium = (forward rate − spot rate) / spot rate

What is the annualized forward premium for a 5% 180-day forward?

The annualized forward premium will be 10%. You can calculate it by using this formula:

annualized forward premium = forward premium × (360 / days) = 5% × (360/180) = 10%