How do you compute and read forward points?

Dealers do not quote forward outrights. They quote forward points — the difference between the forward and the spot, expressed in pips — and the client adds them to whatever spot happens to be at the moment of dealing. Reading points fluently is the core skill of this unit.

The definition and the shortcut

Forward points = (Forward − Spot) × 10,000 for a four-decimal pair.

From the previous lesson, 1.08537 − 1.0800 = 0.00537 → 53.7 points.

There is an approximation that is worth memorising because it makes the driver visible:

Points ≈ Spot × (r_quote − r_base) × t × 10,000

Check it: 1.0800 × (0.0450 − 0.0250) × 0.25 × 10,000 = 54.0 points. Against an exact 53.7 — close enough to use in your head, and it says plainly what the points are: the interest differential, converted into price.

The tenor ladder

Same inputs — spot 1.0800, USD 4.50%, EUR 2.50% — across tenors:

Two things to take away. Points scale almost linearly with time — double the tenor, double the points. And the shortcut drifts as tenor grows, because compounding in the denominator starts to bite. Below six months it is a rounding error; at a year it is five pips, which on a EUR 10,000,000 ticket is USD 5,000 of real money — the quote currency, as pip values always are. Use the exact formula when it matters.

The sign convention

Points are quoted without a sign, as a pair, and the direction is read from the order of the numbers: ascending points are added to spot, descending points are subtracted. A quote of "53.5 / 54.5" is added; "54.5 / 53.5" is subtracted.

The economics behind the sign never change: the higher-yielding currency trades at a forward discount. If the differential flips — the euro's rate rising above the dollar's — the same market quotes negative points and EUR/USD forwards sit below spot.

The proof — two routes, one answer

The exporter from the previous lesson has USD 5,000,000 arriving in three months. Two ways to turn it into euros today, at spot 1.0800 with the same two rates:

Route A — sell it forward. 5,000,000 ÷ 1.0853665 (the unrounded forward) = EUR 4,606,739

Route B — do it yourself with money markets.

1. Borrow the present value of the dollars: 5,000,000 ÷ 1.01125 = USD 4,944,376
2. Convert at spot: 4,944,376 ÷ 1.0800 = EUR 4,578,126
3. Deposit the euros for three months: × 1.00625 = EUR 4,606,739
4. In three months, the dollar receivable repays the dollar loan exactly.

EUR 4,606,739 by both routes — the two cannot be told apart. That equivalence is covered interest parity. The forward is not a bank's view; it is a package of a loan, a deposit and a spot trade, priced so the two routes cannot be arbitraged apart.

Three months later the forward has a value, and half the time it is negative. Suppose spot has fallen to 1.0400 by the value date. USD 5,000,000 would now buy EUR 4,807,692 at spot; the forward delivers EUR 4,606,739, so the contract shows a loss of about EUR 201,000. The receivable has gained the same EUR 201,000, and the company banks the EUR 4,606,739 it budgeted. Had spot risen to 1.1200 the forward would show a gain near EUR 142,000 against an equal loss on the receivable. A hedge that never shows a loss was not a hedge. Report the derivative line and the exposure together, and expect the bank to value the contract the same way when it sizes the credit line.

Where reality diverges

In practice a small, persistent gap survives, because arbitrage consumes balance sheet, capital and credit lines, which are finite. That gap is the cross-currency basis — covered in FX and cross-currency swaps — and it widens sharply when dollar funding is scarce. Add to that the dealer's own bid-offer on the points, which is the actual cost a client pays.

Try it now

1. Euro-dollar spot is below, and the latest overnight reference rate for each leg: SOFR for the dollar, €STR for the euro. Build the four-row tenor ladder above with those numbers.

2. Run the two-route proof on a EUR 1,000,000 receivable. If your two answers differ by more than rounding, one of your day-counts is wrong.
3. Now set both rates equal and recompute. The points collapse to zero — which tells you that the entire forward curve in FX is a picture of one thing: the gap between two interest rates.