FX forward rate (interest-rate parity)
Definition · Level 11 · Pricing toolkit
Keep reading with Tradecraft
Without a subscription, you can read three definitions every 30 days. Tradecraft explains all 988 terms and strategies, with the lessons that teach them, flashcards that come back before you forget, quizzes and a payoff lab.
The exchange rate locked today for a later date, set by the two interest rates, not by a forecast: F = S × (1 + rquote·T) ÷ (1 + rbase·T). This no-arbitrage link is covered interest parity.
Example
EUR/USD 1.1000, USD rate 4%, EUR rate 2%, one year → forward 1.1216.
Where Tradecraft teaches it
Level 11 · Pricing toolkit, in the lesson “FX & commodity forwards”: A currency forward comes from the interest-rate gap (forward points); a commodity forward from storage costs and convenience yield.
Related terms
- Convenience yieldThe benefit of physically holding a commodity (keeping a refinery running, avoiding a stock-out).
- Forward discountA currency whose forward rate buys less of the other currency than spot does.
- FX forward pointsThe forward rate minus spot, counted in pips (0.0001 for most pairs, 0.01 for yen pairs).
- 0.4 ruleAt-the-money-forward call or put ≈ 0.4 × S × σ × √T (small dividends, modest σ√T), because 1/√(2π) ≈ 0.4.
- Arbitrage boundsPrice limits any option must respect, or someone locks in a riskless profit: call ≤ S, European put ≤ K·e^(−rT), call ≥ max(0, S − K·e^(−rT))…
- Backward induction (pricing tree)Solving a problem from the last step back to the first.