Annualizing NDF Forward Points as a Yield or Hedge Cost

Summary

The document explains a way to interpret an annual yield calculated from the difference between NDF bid and ask rates relative to spot. It connects the calculation to the familiar practice of expressing forward points as a proportion of spot, then annualizing that proportion according to the contract tenor. An example uses 50 forward points, a spot rate of 110, and a 91-day period, with an ACT/360 convention, to illustrate the calculation and produce a 1.7820% annualized hedge cost.

The explanation notes that market conventions often use exact day counts, such as ACT/360 or ACT/365, while a simple monthly annualization can approximate the result. It then suggests applying similar reasoning when interpreting the spread as a charge rather than a hedge cost. The discussion is conceptual and does not establish that the original formula is universally standard; the example’s conventions and the distinction between NDFs and other FX forwards may matter in application.

Key ideas

• Forward points can be expressed as a fraction of spot to estimate an FX hedge cost.
• Annualization scales that relative forward cost according to the contract tenor.
• Day-count conventions such as ACT/360 or ACT/365 can affect the annualized figure.
• A spread charge can be interpreted using similar proportional and annualization reasoning.

Tags

# Calculation of annual yield for NDFs


# Calculation of annual yield for NDFs












I was wondering if someone can help me understand how to interpret the "annual yield" that is getting calculated below for NDFs. This is the way it's currently done in the place I work, but not intuitively understanding the formula for it (below).

Any advise would be very appreciated.

For the date to the left, they provide FX spot, Bid and Ask (in outright terms) and arrive to the annual yield (in red), which I don't comprehend conceptually.

Formula used for Annual yield = Annual * (Pips spread / FX spot)

Thank you

## Answer by AKdemy (score 4)

https://quant.stackexchange.com/a/65586

I have never seen this particular formula either but I have seen something similar being used frequently.

Hedge costs are computed as $$(Fwd\ Pts/Spot)/100 $$ and annualized (usually with exact days though, like ACT/360 or ACT/365).

E.g. if

- fwd pts = 50

- spot = 110

- days = 91 (for 3m and daycount subject to convention ) $$ (50/110)/100 = 0.45455 \% $$ $$0.45455\%/(91/360) = 1.7820\% $$

This is what you will find on `ALLX FXHC<GO>` in case you have access to a Bloomberg terminal (tickers like `FXHCUSJP Index` for USDJPY 3m hedge cost)

Note that $1/(30/360)=12$ so it is essentially identical in your formula (annualization).

Now, not thinking of it in terms of cost, but how much spread you charge, you can use a similar argument I guess.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.