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forward premium

The forward point premium is the additional value of a given currency against another, when the forward and spot rates are compared. For example, if spot JPY-USD is 0.009189 and the corresponding 180-day forward rate is 0.009360, JPY trades at a 171-point premium.

The forward premium can also be calculated in percentage terms. In this case, the annualised 180-day JPY premium is 3.72% = [(9360-9189)/9189] x 360/180. The forward premium reflects the interest rate differential between USD and JPY.

In this example, short-term interest rates are lower in JPY than in USD, which explains the forward premium of JPY. The forward rate makes it impossible for arbitrageurs to take advantage of interest rates differentials without risk.