The world of currency exchange can be a foggy landscape to explore for an outsider, filled with alien jargon and complex topics.
One such term that may fit into all three of those categories is the phrase “spot rates”. To help demist this hazy phrase, we’re shining a spotlight on spot rates to clear up any confusion.
What is a Spot Rate?
At its simplest, a spot rate can be defined as a contracted price for a transaction that is taking place immediately (i.e. providing the on-the-spot price there and then).
Spot rates are also sometimes known as “interbank rates” as they are the rate banks and large financial institutions – such as brokerage firms and credit unions – charge each other when trading large sums of foreign currency.
Calculating Spot Rates
Also known as the spot price, the spot rate is based on how much buyers are willing to pay and how much sellers are willing to accept, essentially reflecting supply and demand.
Spot Rates vs Forward Contracts
When discussing spot rates, it’s important to not confuse this with forward rates. Forward rates can best be described as the opposite of a spot rate, typically used to quote a transaction that will take place down the line at a future date, based on the predicted value at the time of settlement.
What is a Spot Contract?
A spot contract is the legally binding agreement relating to the spot trade deal, representing a sworn obligation to buy or sell at the rate agreed between the two parties.
Due to the immediate nature of the valuation, the spot contract usually dictates that a transaction occurs one or two business days from the initial agreed trade date. The date the transaction is initiated on is commonly referred to as the “horizon”.
Spot Rates and Currency
A foreign exchange spot transaction is where one party agrees to purchase one currency by selling another, at a specific price on a set date. This is sometimes referred to as an “FX spot”.
FX spot rates differ from the exchange rate you would see at a typical bureau de change due primarily to the volume of currency exchanged in business vs civilian usage. Think of it as the same way that wholesale prices differ from retail prices.
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