This is a straightforward method, which is based (similar to spot revaluation) on the cost or profit attributable to close the position that is, to enter into a deal at today's rates to cover each deal at its maturity (buy back approach).

In forward deals, the rate varies not only because of a change in the market factors (demand and supply) but also over time. The rate to cover forward deals converges with spot rate over time, that is, closer to maturity, until it is eventually covered at spot rate.

• Interpolation
• Next available rate
• Rate at closest date

Interpolation of FX Rates

• The user can define the rates in FORWARD.RATES table for any period required.

• The forward rates applied for actual date = Reporting date + 2 working days + number of months
• If this date is not a working day, then the next working day is used.
• When a rate is required for a date that falls between the dates of two rates on the table, then it is calculated by linear interpolation.

If a yield on GBP is 12%, which is on USD is 14% with a spot rate of 1.25. Then, in 12 months

• GBP 1000 would yield GBP 120 interest.

Similarly, if exchanged (@1.25)

• USD 1250 would yield USD 175 interest.

Thus, in order not to sustain a loss, the 12 months forward USD sell rate should be USD 1425/GBP1120 or 1.2723, that is,

• USD 1425 / 1.2723 = GBP 1120

In practice, one of the amounts on the forward deal is held at the same value as for the spot deal. So, in this example, if the forward deal is also for GBP 1000 the USD amount is USD 1275, which is, USD 1250 plus 2% interest differential thereon of USD 25.

Therefore, the discount on the forward USD 12 months rate is to offset the 2% USD interest premium prevailing at the time of the deal. This exchange of profit or loss is accrued over the life cycle of the forward deal, that is, the straight line method, except the profit and loss interest entries are now booked for both the currency bought (credit to Interest Received Exchange) and sold (debit to Interest Paid Exchange).

Using the Same Example

A loan of USD 1250 yields USD 175 in 12 months. In the same time, a debit (revaluation) accrual is made of USD 25 (that is, USD 1250 * 2%). Thus the net result is interest received of USD 150.

As proof that this is correct, GBP 1000 at 12% would have given rise to GBP 120 interest, which converted at spot of 1.25 is also USD 150.

The effect of this accrual (to discount the forward premium or discount) is to value the position at spot rate, therefore, it is necessary to perform spot revaluation every day.

This method is appropriate for swap transaction type, where an actual loan and deposit is booked with a spot and forward deal and real interest rates are used on the forward leg. Hence, to render the deal entirely neutral, that is, the forward accrual eliminates the difference between interest paid and received and the spot deal is cancelled (as the effect of spot revaluation of the forward leg).

As mentioned above, there is a difference between spot and forward rates. In this method, the difference is the amount in local currency is isolated as profit or loss at the start of the contract and then amortised over the life cycle of the deal as a daily accrual between the appropriate interest profit and loss category code (Interest Paid Exchange or Interest Received Exchange) and the exchange reserve adjustment account.

The following ACCOUNT.CLASS records are used to obtain the internal account category:

Effectively this deal is now being carried at spot rate (since the forward discount or premium is being accrued) and therefore, it is necessary to revalue this every day as if it was a spot deal (by using the technique described in spot revaluation). The rate at which it is re-valued is the Reval Rate (if specified on the CURRENCY table), otherwise uses Mid Reval Rate.

This method is primarily for the swap contract type and similar to the SL method except that the premium or discount of a swap is amortised over the contract period in the currency in which the premium or discount arises (that is, the currency, which differs in amount between the legs of the deal).

Similar to interest method, the revaluation type considers the difference in the interest yields of the contract currencies. However, the interest calculation of interest or hedge method is not based on the contractual amounts of the deal but on a notional principal amount on each side (buy and sell).

The notional principal amount is the present value (PV) of the contractual amounts. In other words, the notional principal amount, when applied the interest rates applicable to each currency of the contract, yields the contractual amounts of the deal over the contract term. This means, the deal amounts are effectively split into a principal and interest element and it is this interest element, which is accrued on each side of the deal over its life.

The difference between the interest and interest or hedged methods are illustrated below:

In all cases, the USD interest rate is 14% and GBP interest rate is 12%. The spot rate of exchange between the two currencies is 1.25. The forward rates refer to 12 months forward contract.

This method of calculating interest yields associated, with a forward contract is appropriate to a hedging situation where a forward foreign exchange deal is made in cover of balance sheet items.

Since the notional principal amounts correspond to an actual spot transaction and are not the same as the resultant forward contract amounts, this revaluation type is not available for use on first leg of the swap contracts, if the swap is a SP-FWD.