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Forward Exchange Rate
An understanding of forward rates is fundamental to IRP, especially as it pertains to arbitrage. Forward exchange rates for currencies are exchange rates at a future point in time, as opposed to spot exchange rates, which are current rates. Forward rates are available from banks and currency dealers for periods ranging from less than a week to as far out as five years and more. As with spot currency quotations, forwards are quoted with a bid-ask spread.
The difference between the forward rate and spot rate is known as swap points. If this difference (forward rate minus spot rate) is positive, it is known as a forward premium; a negative difference is termed a forward discount.
A currency with lower interest rates will trade at a forward premium in relation to a currency with a higher interest rate. For example, the U.S. dollar typically trades at a forward premium against the Canadian dollar. Conversely, the Canadian dollar trades at a forward discount versus the U.S. dollar.
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