We are independent & ad-supported. We may earn a commission for purchases made through our links.
Advertiser Disclosure
Our website is an independent, advertising-supported platform. We provide our content free of charge to our readers, and to keep it that way, we rely on revenue generated through advertisements and affiliate partnerships. This means that when you click on certain links on our site and make a purchase, we may earn a commission. Learn more.
How We Make Money
We sustain our operations through affiliate commissions and advertising. If you click on an affiliate link and make a purchase, we may receive a commission from the merchant at no additional cost to you. We also display advertisements on our website, which help generate revenue to support our work and keep our content free for readers. Our editorial team operates independently of our advertising and affiliate partnerships to ensure that our content remains unbiased and focused on providing you with the best information and recommendations based on thorough research and honest evaluations. To remain transparent, we’ve provided a list of our current affiliate partners here.
Finance

Our Promise to you

Founded in 2002, our company has been a trusted resource for readers seeking informative and engaging content. Our dedication to quality remains unwavering—and will never change. We follow a strict editorial policy, ensuring that our content is authored by highly qualified professionals and edited by subject matter experts. This guarantees that everything we publish is objective, accurate, and trustworthy.

Over the years, we've refined our approach to cover a wide range of topics, providing readers with reliable and practical advice to enhance their knowledge and skills. That's why millions of readers turn to us each year. Join us in celebrating the joy of learning, guided by standards you can trust.

What is a Forward Discount?

Jim B.
By
Updated: May 17, 2024

A forward discount occurs when the spot exchange rate of a foreign currency exceeds that same country's forward exchange rate in a futures contract. This type of situation comes into play when forward trades of currencies are made, which means that no currency changes hands until the maturity date of the futures contract is reached. The concept is the opposite of a forward premium, in which the forward rate exceeds the current rate. Although a forward discount may be predicted by current rates, there is no guarantee that the future rates will live up to this prediction.

Foreign exchange trades are dependent on the interest rates of the countries involved in these trades. Discrepancies between these rates are often a way for traders in the foreign exchange market to get in and out of trades and make a quick profit. When these trades involving foreign exchange rates are made via future contracts, then the current rate of exchange is irrelevant and the future rate becomes all-important. These future trades are where the concept of a forward discount takes place.

When a future trade is made, there is no currency exchange when the contract for the trade is made. Instead, the trade actually takes place as determined by the contract at some time in the future. The forward rate is therefore the rate at the time that the contract stipulates the future trade will be made. For instance, if the future contract is set up for a period of one month, then the applicable rate will be the rate of exchange one month in the future.

What occurs then is that the current rate of exchange will either rise or fall in the span of time that the contract takes place. If the future rate falls below the current rate, then a forward discount is the result. When the opposite occurs, then a forward premium is said to take place. These results are important to those traders who are hedging investments by making a trade with a current rate and then following that up with a futures contract to protect against losses.

The problem with trying to anticipate a forward discount is that the predicted future rates don't always come to fruition. For example, if there is a 1-percent rate difference in the interest rates of two countries at the time of the trade, the prevailing theory is that those rates will even out at the time of the future contract's maturation, with the lower rate appreciating and the higher rate depreciating. But future rates, as determined at the time the futures contract is enacted, often vary from what actually takes place. This conundrum is known to investors as the forward discount puzzle.

WiseGeek is dedicated to providing accurate and trustworthy information. We carefully select reputable sources and employ a rigorous fact-checking process to maintain the highest standards. To learn more about our commitment to accuracy, read our editorial process.
Jim B.
By Jim B.
Freelance writer - Jim Beviglia has made a name for himself by writing for national publications and creating his own successful blog. His passion led to a popular book series, which has gained the attention of fans worldwide. With a background in journalism, Beviglia brings his love for storytelling to his writing career where he engages readers with his unique insights.
Discussion Comments
Jim B.
Jim B.
Freelance writer - Jim Beviglia has made a name for himself by writing for national publications and creating his own...
Learn more
Share
WiseGeek, in your inbox

Our latest articles, guides, and more, delivered daily.

WiseGeek, in your inbox

Our latest articles, guides, and more, delivered daily.