Forward Premium

A forward premium is the difference between the forward price of an asset and its spot price. It is a positive value when the forward price is higher than the spot price, and a negative value when the forward price is lower than the spot price.

The forward premium is a measure of the expected future return on an asset. It is calculated as follows:

Forward premium = (Forward price - Spot price) / Spot price

The forward premium can be used to make an informed decision about whether to buy or sell an asset. If the forward premium is positive, it means that the market expects the asset to appreciate in value over the life of the forward contract. This suggests that it is a good time to buy the asset. Conversely, if the forward premium is negative, it means that the market expects the asset to depreciate in value over the life of the forward contract. This suggests that it is a good time to sell the asset.

The forward premium is also used to calculate the implied forward rate of interest. The implied forward rate of interest is the interest rate that would make the forward price of an asset equal to its spot price. It is calculated as follows:

Implied forward rate of interest = (Forward price - Spot price) / (Spot price * Time to maturity)

The implied forward rate of interest can be used to compare the relative attractiveness of different investments. If the implied forward rate of interest on an asset is higher than the interest rate on a risk-free investment, it means that the asset is a good investment. Conversely, if the implied forward rate of interest on an asset is lower than the interest rate on a risk-free investment, it means that the asset is a bad investment.

The forward premium is an important concept in finance. It can be used to make informed decisions about whether to buy or sell an asset, and to compare the relative attractiveness of different investments.