Currency Forward Fair Value Calculator
Compute the theoretical fair value of a currency forward contract using covered interest rate parity. Ideal for exporters, importers, and treasury teams locking in future exchange rates.
About this calculator
The fair value of a currency forward is derived from covered interest rate parity (CIP), which states that any difference in interest rates between two countries must be offset by a corresponding change in the forward exchange rate to prevent arbitrage. The formula is: Forward Rate = Spot Rate × (1 + Domestic Rate)^(T) / (1 + Foreign Rate)^(T), where T = Forward Tenor / 365 expressed as a fraction of a year. If the domestic interest rate is higher than the foreign rate, the forward rate will be above the spot rate (forward premium on domestic currency). Conversely, lower domestic rates produce a forward discount. This relationship is exploited in covered interest arbitrage and underpins virtually all forward FX pricing in institutional markets.
How to use
Say USD/JPY spot rate = 150.00, US risk-free rate = 5%, Japanese risk-free rate = 0.5%, forward tenor = 90 days. T = 90/365 ≈ 0.2466. Numerator: (1 + 0.05)^0.2466 = 1.05^0.2466 ≈ 1.01214. Denominator: (1 + 0.005)^0.2466 ≈ 1.00123. Forward Rate = 150.00 × 1.01214 / 1.00123 = 150.00 × 1.01089 ≈ 151.63. The 90-day forward rate is approximately 151.63, reflecting the higher US interest rate relative to Japan's.
Frequently asked questions
Why does covered interest rate parity determine currency forward rates?
Covered interest rate parity ensures that an investor cannot earn a risk-free profit by borrowing in a low-rate currency, converting to a high-rate currency, investing, and locking in the forward rate simultaneously. If the forward rate deviated from the CIP formula, arbitrageurs would immediately exploit the gap, pushing the forward rate back into alignment. This makes CIP the foundational no-arbitrage condition for forward FX pricing. In practice, small deviations from CIP exist due to credit risk, transaction costs, and regulatory capital constraints.
What is the difference between a forward rate and a futures rate in FX markets?
Both forward rates and FX futures represent agreed exchange rates for a future date, but they differ structurally. FX forwards are over-the-counter contracts customised to exact notional amounts and delivery dates, and are settled at maturity. FX futures are standardised exchange-traded contracts with daily mark-to-market margining. The theoretical fair value formula applies to both, but futures prices can diverge slightly from forwards due to the convexity adjustment arising from daily settlement. For most practical hedging purposes, the two rates are very close.
How can a company use the forward fair value to hedge currency risk?
A company expecting to receive foreign currency in 90 days can lock in today's forward rate to eliminate uncertainty about the future exchange rate. If the fair value forward rate is more favourable than the spot rate (e.g., a forward premium for the currency they will receive), the hedge also delivers an economic benefit. By comparing the calculated fair value to broker-quoted forward rates, treasurers can verify they are not being overcharged. If a significant gap exists between the fair value and the quoted rate, it may be worth shopping for better pricing.