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Calculating Premiums and Discounts

In: The Exporter’s & Importer’s Handbook on Foreign Currencies

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  • A. D. P. Edwards

Abstract

In calculating the forward rate of exchange a premium is always subtracted from the spot rate and a discount is always added to the spot rate, par indicates that there is no premium and no discount and so the forward rate will be the same as the spot rate. In accordance with Figure 1 below if you had been exporting and delivering the dollars to the bank in about one month’s time, you would have sold them at a premium of 0.61 cents. Because this is a premium, it is a minus quantity and you subtract 0.61 cent from 54.00 cents. Be very careful of that point, the spot rate is one dollar 54.00 cents and the premium is 0.61 cents. The one month forward rate for exports is therefore $1.5339 = £1. If you had been delivering the dollars in about three months you would have sold them to the bank at a premium of 1.82 cents resulting in a forward rate of $1.5218 = £1. Against the spot rate $1.5400, at which you converted your sterling price into dollars, the premiums of 0.61 cent and 1.82 cents would have yielded an extra £40 and £120 respectively at a cost of only a phone call. You would have fixed the sterling price of that dollar sale at the time you made the sale which is what you would have done if you had sold in sterling but you have now made more profit. You do not have to try and guess as to what the order will bring in. The exchange rate is fixed and that is the end of the sale.

Suggested Citation

  • A. D. P. Edwards, 1990. "Calculating Premiums and Discounts," Palgrave Macmillan Books, in: The Exporter’s & Importer’s Handbook on Foreign Currencies, chapter 6, pages 35-39, Palgrave Macmillan.
    • Handle: RePEc:pal:palchp:978-1-349-11852-6_7
    DOI: 10.1007/978-1-349-11852-6_7
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