Price Arbitrage
The forward price of an asset which is held as an investment is not a function of a forecast but of the yield of the asset and the prevailing interest rate. The most widely held investment is cash and the most commonly traded forward in the FEC. To illustrate why forward prices are not based on forecast, consider the forward AUD/USD price quoted by ABC Bank below.

The current spot price is 0.800. ABC Bank's FX dealer believes the AUD will depreciate against the USD in 1yr and the price will be at 0.7500, the price offered by the market.

The market arbitrageur can borrow or lend AUD for 1yr at an interest rate of 8% and USD at 3%. A risk-free profit can be made in these circumstances as follows (Right):

The implicit exchange rate of 0.7630 is the rate achieved through buying USD 'SPT', lending the USD$ and borrowing the AUD$. The rate is the ratio of net USD$ and AUD$ cashflows: 1,030/1,350 = 0.7630. In this example, the arbitrageur could buy AUD 'FWD' from ABC @ 0.7500 and sell the AUD FWD, by way of the SPT, borrowing and lending at 0.7630.

This transaction would provide the arbitrageur with a profit of $23 per $1000 or $23,000 profit per $1,000,000. Other arbitrageurs would take advantage of this opportunity and drive the FWD price towards the implicit rate resulting from the SPT deal, loan and deposit.

This interest rate differential FWD price model holds true for all investment assets. The asset yield can take different forms - the dividend yield in the case of stocks, the coupon rate in the case of bonds - but the FWD price model as a function of the SPT price, the asset yield and the cash interest rate remains valid. Date USD Cashflow Exchange Rate AUD Cashflow
Borrow AUD 1,250 for 1 yr @ 8% Today 1,250.00
Buy USD 1,000 @ 0.8000 with a SPT deal 1,000.00 0.8000 -1,250.00
Lend USD 1,000 for 1yr @ 3% -1,000.00
Repay AUD 1,250 plus AUD 100 interest +1yr -1,350.00
Receive back USD 1,000 plus USD 30 interest 1,030.00
Implicit exchange rate in the repayment and receipt 0.7630
Sell USD to ABC Bank @ 0.7500 -1,030.00 0.7500 1,373.33
Profit 0.00 23.33