PREMIUM AND DISCOUNT

If the forward exchange rate for a currency is more than the spot rate, a
premium exists for that currency
Premium = Forward > Spot
A discount happens when the forward exchange rate is less than the spot
rate. A negative premium is equivalent to a discount
Discount = Forward < Spot
The annualized percentage between spot rate and forward
rate is called forward premium or discount
Annualized forward margin(AFM) =
[(Forward rate - Spot rate) / Spot rate] x (12/m) x 100
OR
[(Forward rate - Spot rate) / Spot rate] x (365/d) x 100

Prof Virani Charmi International Finance

 Holgate Principle
This principles states that :
Premium on base currency is always added to the spot
rate to arrive at the corresponding forward rate
Discount on base currency is always subtracted from the
spot rate to arrive at the corresponding forward rate

Premium on base currency implies discount on variable

currency
And
Discount on base currency implies premium on variable
currency

Prof Virani Charmi International Finance

 Holgate Principle
If Bid > Ask
Points are subtracted from the spot
If Bid < Ask
Points are Added to the spot
This is also known as “High-Low” or “Low-High” Rule
“High-Low” Rule:
If the bid points are higher ,the spot rate has to be made lower (by
subtracting bid ask points from spot bid ask rates) to find forward
bid ask rate
“Low-High” Rule:
If the bid points are lower ,the spot rate has to be made high(by
adding bid ask points to spot bid ask rates) to find forward bid ask
rate

Prof Virani Charmi International Finance

 Example 1:
Calculate the forward buying and selling rates from the
following information
Spot USD 1= Rs 70.6000/70.9000
a One month 1000/1100
b Two months 1200/1300
c Three months 1400/1500
d Four months 1550/1600

Prof Virani Charmi International Finance

 Solution:
BID ASK
Spot USD INR 70.6000 70.9000
a Swap points One month 1000 1100
b Swap points Two months 1200 1300
c Swap points Three months 1400 1500
d Swap points Four months 1550 1600

As per Holgate principle,

To find forward rate:
1. Premium on base currency is added to spot rate
2. Discount on base currency is subtracted from spot rate

Prof Virani Charmi International Finance

 Solution:
(USD INR) BID (USD INR) ASK
Spot USD INR 70.6000 70.9000
a Swap points One month
BID 1000 < ASK 1100
Premium added to spot 70.7000 71.0100

b Swap points Two months

BID 1200 < ASK 1300
Premium added to spot 70.7200 71.0300

c Swap points Three months

BID 1400 < ASK 1500
Premium added to spot 70.7400 71.0500

Prof Virani Charmi International Finance

 Solution:
(USD INR) BID (USD INR) ASK
d Swap points Four months
BID 1550 < ASK 1600
Premium added to spot 70.7550 71.0600

Spot USD INR 70.7000 / 70.0100

Forward 1 month USD INR 70.7000/71.0100
Forward 2 month USD INR 70.7200/71.0300
Forward 3 month USD INR 70.7400/71.0500
Forward 4 month USD INR 70.7550/71.0600

Prof Virani Charmi International Finance

 Example 2:
Calculate the forward rates of Euro to Rupee for following
information:
Spot 1 USD = INR 60.6010 / 50
Spot 1 EURO = USD 1.3787/97

Dollar to Rupee Swap Points Euro to Dollar Swap Points

1 month 20/30 1 month 30/25
2 months 40/50 2 months 60/50
3 months 60/70 3 months 80/70
4 months 80/90 4 months 95/90

Prof Virani Charmi International Finance

 Solution:
Given BID ASK Given BID ASK
Spot USD INR 60.6010 60.6050 Spot EUR USD 1.3787 1.3797
Swap points 1 20 30 Swap points 1 30 25
month month
Swap points 2 40 50 Swap points 2 60 50
months months
Swap points 3 60 70 Swap points 3 80 70
months months
Swap points 4 80 90 Swap points 4 95 90
months months

To find forward rates of EUR INR:

(EUR USD )bid x (USD INR)bid

(EUR USD )ask x (USD INR)ask
Prof Virani Charmi International Finance
 To find forward rates of EUR INR:
( EUR INR ) bid = ( EUR USD ) bid x ( USD INR ) bid
( EUR INR ) Ask = ( EUR USD ) Ask x ( USD INR ) ask

USD INR EUR USD EUR INR

BID ASK BID ASK BID ASK

a b c d axc bxd
Spot 60.6010 60.6050 1.3787 1.3797 83.5506 83.6167
1 month 60.6030 60.6080 1.3757 1.3772 83.3715 83.4693
Bid 20 < Ask 30 Bid 30 > Ask 25
Premium added to Discount
spot rate subtracted from
spot rate
60.6010 60.6050 1.3787 1.3797
+ + - -
0.0020 0.0030 0.0030 0.0025

Prof Virani Charmi International Finance

 To find forward rates of EUR INR:
( EUR INR ) bid = ( EUR USD ) bid x ( USD INR ) bid
( EUR INR ) Ask = ( EUR USD ) Ask x ( USD INR ) ask

USD INR EUR USD EUR INR

BID ASK BID ASK BID ASK

a b c d axc bxd
Spot 60.6010 60.6050 1.3787 1.3797 83.5506 83.6167
2 month 60.6050 60.6100 1.3727 1.3747
Bid 40 < Ask 50 Bid 60 > Ask 50
Premium added to Discount
spot rate subtracted from
spot rate
60.6010 60.6050 1.3787 1.3797
+ + - -
0.0040 0.0050 0.0060 0.0050

Prof Virani Charmi International Finance

 Spot EUR INR 83.5506 / 83.6167

Forward 1 month EUR INR 83.3715 / 83.4693

Forward 2 month EUR INR 83.1925 / 83.3206

Forward 3 month EUR INR 83.0740 / 83.2021

Forward 4 month EUR INR 82.9858 / 83.0836

Prof Virani Charmi International Finance