Usually, the forward exchange rate differs from the spot rate of the underlying currency pair. If the forward rate is higher than the spot rate, we refer to forward premium and when the opposite is true – the term forward discount is used. The discrepancy in both rates reflects interest differentials for the two underlying currencies. If deposits, denominated in one of the two currencies, bear higher interest and that currency is sold forward, the seller is entitled to receive interest payments until the maturity date. In such a case the buyer of the forward is in a more unfavorable situation as he or she will not be able to make a deposit in the higher-interest-bearing currency until some time has elapsed. If the forward rate is lower than the spot rate, the buyer is compensated by the difference.
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