Trading and Relative Value · Forwards Trading Guide
Currency carry can produce income in quiet markets and losses during sharp exchange rate moves. Forward points are part of the entry economics, not guaranteed profit.
Connect carry with the forward price
A currency with a higher interest rate often trades at a forward discount when quoted as units of a lower rate currency per unit of that currency. Buying it forward can benefit if its future spot rate remains near today’s level. This is an exposure to the realised currency outcome relative to the forward, not a riskless receipt of the interest differential.
Use a simple example
Assume a fictional currency is worth $0.050 today and its one year forward price is $0.048. Buying 1 million units forward would gain $2,000 if the maturity spot remains $0.050. If the currency falls to $0.044, the forward loses $4,000. The apparent $2,000 carry advantage does not cap the possible loss or determine its probability.
Avoid double counting
For a forward held without a separate foreign deposit, do not add a full foreign interest receipt to the contract’s payoff. The funding differential already influences the forward price. Cash collateral can earn or incur interest according to its own terms and should be recorded separately. Compare returns using a clearly stated capital or notional denominator rather than whichever makes the result look largest.
Examine crowded exits
Carry strategies can share exposure to global funding and risk sentiment. Several currency positions may lose together even if they involve different countries. Stress abrupt depreciation, wider spreads and more expensive funding. A calm historical average does not describe the cash needed during a severe move. Record the economic reason for the position and a rule for reassessing it when that reason changes.
Try it yourself
A long forward covers 500,000 currency units at $0.072 each. The maturity spot is $0.070. Is the result positive simply because the currency had a high interest rate?
Show the worked answer
No. The forward loses $1,000 before costs. The realised rate is below the contractual purchase price, regardless of the original carry rationale.
Further reading
- CFA Institute: Currency exchange rates and equilibrium value
- CFA Institute: Currency management
- BIS: FX hedging demand and costly balance sheets
Educational material. Numerical examples are hypothetical and exclude costs unless stated. Forward contracts create binding obligations and may require collateral or credit approval. Actual terms, access and risks depend on the agreement and jurisdiction.
