4.1. INTRODUCTION TO FORWARD CONTRACTS 125
Table 4.1:Spot and Forward Quotes, Mid-market rates in Toronto at noon
(Outright) (Swap rates)
Premium or discount, in cents
CAD per USD USD per CAD CAD per USD USD per CAD
U.S. Canada spot 1.3211 0.7569
1monthforward 1.3218 0.7565 +0.07 –0.05
2 months forward 1.3224 0.7562 +0.13 –0.07
3 months forward 1.3229 0.7559 +0.18 –0.10
6 months forward 1.3246 0.7549 +0.35 –0.20
12 months forward 1.3266 0.7538 +0.55 –0.31
3 years forward 1.3316 0.7510 +1.05 –0.59
5 years forward 1.3579 0.7364 +3.68 –0.05
7 years forward 1.3921 0.7183 +7.10 –3.86
10 years forward 1.4546 0.6875 +13.36 –6.94Source Globe and Mail.
eration. The rightmost two columns in Table 4.1 shows howThe Globe and Mail
quotes would have looked in swap-rate form. In that table, the sign of the swap rate
is indicated by a plus sign or a minus sign. TheFinancial Timesused to denote
the sign as pm (premium) or dis (discount).
The origin of the term swap rate is the swap contract. In the context of the
forward market, a swap contract is a spot contract immediately combined with a
forward contract in the opposite direction.
Example 4.2
To invest in theusstock market for a few months, a Portuguese investor buysusd
100,000 ateur/usd1.10. In order to reduce the exchange risk, she immediately
sells forwardusd100,000 for ninety days, ateur/usd1.101. The combined spot
and forward contract—in opposite directions—is a swap contract. The swap rate,
eur/usd0.1(cent), is the difference between the rate at which the investor buys
and the rate at which she sells.
To emphasize the difference between a stand-alone forward contract and a swap
contract, a stand-alone forward contract is sometimes called an outright contract.
Thus, the two quoting conventions described above have their roots in the two types
of contracts. Today, the outright rate and the swap rate are simply ways of quoting,
used whether or not you combine the forward trade with a reverse spot trade.^2
One key result of this chapter is that there is a one-to-one link between the swap(^2) Sometimes the swap rate is called the cost of the swap, but to financial economists that is a
very dubious concept: at the moment the contract is initiated, both the spot and the forward part
are zero-NPVdeals, that is, their market value is zero. So the swap rate is not the cost of the swap
in the same way a stock price measures the cost of a stock. It is more like an accounting concept
of cost, in the style of the interest being the cost of a loan.