The Treasurer’s Guide to Trade Finance

A Reference Guide to Trade Finance Techniques

Foreign exchange calculations

Forward exchange rates

When importing from abroad, treasury may
want to fix a future exchange rate to ensure
access to the required foreign currency on
the payment date. This is possible through
the use of a forward foreign exchange rate,
which allows the company to fix the rate
without committing cash until the payment
date. Forward foreign exchange rates are
calculated from the spot rate between the
two currencies and the respective currency
interest rates.
To calculate a forward exchange rate
between the Euro and the US dollar for
60 days’ time, we would use the following
equation:

forward rate = spot rate × [1 + (rv × d/y)]

[(1 + (rb × d/y)]

where rv is the variable currency interest rate,
rb is the base currency interest rate, d is the
number of days until settlement and y is the
number of days in the year. By convention all
currency pairs are quoted in the same way.
The first named currency is the base currency
and the second is the variable currency. In
most cases, the US dollar is quoted first (the
exceptions against the US dollar are GBP,
EUR, AUD and NZD, which are quoted first).
For example, to calculate the EUR/USD
exchange rate 120 days forward when the
spot rate is 1.40, with the EUR interest rate
1.75% and the USD interest rate 1.0%, we
use the formula:

forward rate = 1.4 × [1 + (0.01 × 120/360)]

[1 + (0.0175 × 120/360)]

= 1.397

This can also be calculated using a points

adjustment. In this case, the formula is

forward rate =

spot rate + [spot rate × (rv – rb) × d/y]

Using the example above:

forward rate =

1.4 + [1.4 × (0.01 – 0.0175) × 120/360]

= 1.397

By convention, exchange rates are quoted

with a bid/offer rate. The bid rate is the rate

at which the counterparty bank will buy the

currency from the company and the offer

rate is the rate at which the counterparty

bank will sell the currency to the company.

For example, the spot EUR/USD exchange

rate may be quoted as 1.3999/1.4001. This

shows a bank will sell USD 1.3999 for EUR 1.

A company would need to sell USD 1.4001 to

receive EUR 1.

Forward rates are usually quoted in terms

of the differential between the spot and the

forward rate. For example, the spot GBP/

USD rate could be 1.7625/1.7629, with

forward points at 50/48. Because the larger

number comes first, this means the points

should be subtracted from the spot rate

(indicating that US interest rates are higher

than UK rates at the time of the quote). If

the rate was quoted as 1.7625/1.7629, with

forward points at 48/50, the points should be

added to the spot rate, implying UK rates are

higher than US rates. Finally, it is important

to remember that spreads for forward rates

are always greater than those for spot rates,

a useful check that you have the convention

the right way round.