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Glossary

Forward Premium

A forward premium is the amount by which a currency's forward exchange rate exceeds its spot rate, usually expressed as an annualized percentage, and it typically reflects the interest rate gap between two countries.

What Is a Forward Premium?

A forward premium is a situation in the foreign exchange market where a currency costs more for delivery on a future date than for delivery today. If the forward exchange rate for a currency is higher than its spot rate, that currency is said to trade at a premium against the other currency. The reverse situation is called a forward discount.

How It Works

Forward rates are set through agreements that lock in an exchange rate for a future date. The forward premium largely reflects the interest rate differential between the two countries. Under covered interest rate parity, an investor should earn the same return whether they invest directly in one currency or convert to the other, invest at local rates, and lock in the conversion back with a forward contract. For this to hold, the currency with the lower interest rate trades at a forward premium against the currency with the higher rate.

The annualized forward premium can be approximated as:

Forward premium ≈ (Forward rate − Spot rate) ÷ Spot rate × (days in a year ÷ days to maturity)

Day-count conventions vary by market, so the exact figure depends on the quoting method.

Why It Matters to Investors

Consider an exporter who expects to receive foreign payment in six months. If the foreign currency trades at a forward premium, selling it forward yields more domestic currency per unit than converting at today's spot rate. This is a locked-in trade-off, not a guaranteed profit.

Investors use forward premiums to compare hedged and unhedged returns on foreign bonds and deposits, since the premium can offset or add to the yield difference. However, a forward rate is not a forecast of the future spot rate. Research has often found that currencies trading at a forward premium do not depreciate as much as the forward rate implies, a pattern known as the forward premium puzzle. Investors should also remember that forward contracts carry counterparty risk and reduce flexibility.

Updated October 31, 2026. For general education only; not financial, tax or legal advice.

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Related Terms

Spot Rate

A spot rate is the current price at which a commodity, security, or currency can be bought or sold for immediate delivery, as opposed to a price agreed today for a future date.

Interest Rate Differential (IRD)

An interest rate differential (IRD) is the difference between two interest rates, such as those on two currencies, bonds, or loans, used to compare returns, price currency forwards, and set mortgage penalties.

Covered Interest Rate Parity (CIP)

Covered interest rate parity is a no-arbitrage relationship stating that the difference between two countries' interest rates equals the gap between the forward and spot exchange rates for their currencies.

Forward Contract

A forward contract is a private agreement between two parties to buy or sell an asset at a set price on a future date, traded over the counter rather than on an exchange.