Meaning and Factors of Forward Margins/Swap Points - Forex Management

Since the foreign exchange rate will be fluctuation, the spot rate of the currency will not be the same at a future date, i.e., after one month or so. If the forward rate and spot rate happen to be the same, then it is called at par. That is forward rate is at par with spot. This will be very rate in foreign exchange transactions, unless the currencies in question are steady and stable for a pretty long time. Generally the forward rate of a currency will be costlier or cheaper than spot rate. The difference between the spot rate and the forward rate is known as Forward Margin, otherwise called Swap Points. The forward margin may be either at premium or at discount. In the former case, the forward rate will be cheaper than the spot rate. Under direct quotation, premium is added to spot rate to arrive at the forward rate. This is done for both purchase and sale transaction. Discount is deducted from the spot rate to arrive at the forward rate.

Factors Determining Forward Margin
In this section, we shall briefly study about the factors that determine the forward margin.
Rate of Interest
The prevailing rate of interest at home and also in the foreign country from which we want to get foreign exchange decide the forward margin. To put it shortly, it depends upon the differences in the rate of interest prevailing at the home centre and the concerned foreign centre. If the rate of interest at the foreign centre is higher that the rate of interest prevailing at home centre, naturally, the interest gained by investing in the foreign centre will be more than the interest gained at home centre. If the rate of interest at the foreign centre is higher than the home centre, the forward margin would be at discount. Conversely if the rate of interest is lower in the foreign centre and higher in the home centre, the forward margin would be at premium.

Demand and Supply of Foreign Currency
This is similar to the principle of demand and supply of a commodity. If a particular foreign currency is in great demand than its supply, then, naturally, it will be costlier and it will be sold at a premium. If the supply exceeds the demand, the forward rate will be at a discount.

Investment Activities
Another factor influencing forward margin will be due to the hectic activities of investments, taking advantage of differences in the rate of interest between one centre and another. The investor may borrow from low interest centre and invest the amount in the high interest centre. For example, the investor may borrow at London at the rate of 5% p.a. and invest the amount in Chennai at 12% p.a. In order to secure his position, he may cover up his transaction in the forward marker. Then, he will sell spot pound-sterling and buy forward pound-sterling. When many investors do like this, the supply of spot Pound-Sterling increases abundantly putting down the price. The demand for forward pound-sterling increases, pushing up the price.

Speculative Activities Regarding Spot Rates
The forward rates are based on spot rates. Any speculation in the movement of spot rates would also influence forward rates. If exchange dealers anticipate spot rate to appreciate, they will quote forward rate at a premium. If they expect the spot rate to depreciate, the forward rate would be quoted at a discount.

Exchange Regulation
Exchange control regulations may also put restrictions or conditions on the forward dealing, leading to change in forward margin. Such restrictions may be with respect to keeping of balances abroad, borrowing overseas etc. If the Central Bank of the country intervenes in the forward market, this will influence forward margin.

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