Question

Explain the meaning of the forward discount of the $ relative to Euro. If the forward discount of the $ relative to Euro is 5%, does this mean that the forward premium of the Euro relative to the dollar is 5%? Why or why not?

Answer 1

Fwd Discount of $ = (Spot Rate - Fwd rate ) / Fwd rate * 100

For example Spot rate is 1 Euro = 1.5 $ & Fwd rate is $1.5789

= ($1.5 - $1.5789) / $ 1.5789 * 100

(- 0.0789 / 1.5789 ) * 100

= - 0.05

Forward premium of Euro = (Fwd rate - Spot rate ) / Spot rate * 100

= ($ 1.5789 - $ 1.5) / $ 1.5 * 100

= ( $ 0.0789 / $ 1.5) * 100

= 0.0526 i.e 5.26%

In the given example, I have considered a case where $ discount is 5% compared to Euro

But Euro premium over $ is 5.26%

Thus Euro premium relative to USD is not 5% and it is 5.26%