What are forward points?

When an investor enters into a forward currency contract they are generally quoted forward points. Forward points are added or subtracted to the spot rate and are determined by prevailing interest rates in the two currencies (remember: currencies always trade in pairs) and the length of the contract. Typically, the higher yielding currency has negative points, while the lower yielding currency has positive points. That is to say that if a currency has a relatively higher yield then it will typically cost less in the forward market, if a currency has a relatively lower yield it will typically cost more in the forward market. If this did not hold true, an arbitrage situation may be presented, which in itself could drive prices to equilibrium.

Forward points are commonly quoted in fractions of 1/10,000; +20 points would mean add 0.002 to the spot rate. As an example, if an investor wished to purchase Australian dollars (AUD) using a forward currency contract, and was quoted AUD at 0.9000 minus 55.55 points, the forward rate would be 0.894445.