Spot exchange rate : What is it?

Spot exchange rate : What is it?

24 Feb 2020 05:08 PM

Often one is made to believe the currency conversion quotes one gets from the bank for exchanging a currency into another is the same rate at which the currency markets also exchange. The banks have a quote displayed in their premises which is probably set for the day for their retail clients. Since retail means lower volume, the bank tend to over-charge the rates for buying a foreign currency while may lower the rate while selling the foreign currency. It is left to the client to figure out the rate which is prevailing in the market is same as that quoted by the bank.

In this time of technology, with most information available online, the currency conversion rates are if not the real time but may be delayed is available at the touch of a button. Similarly with small and medium enterprises it often noticed the difference in rate which the bank quotes to them compared to rates quoted to larger enterprises. Sometimes the exchange rate also depends on the size of the transaction. The volume is sizeable, will give the enterprise more negotiating powers compared to a small enterprise. Apart from this over charging of rates, the banks also charge a bank margin and documentation charges for processing the foreign exchange rate for the international currency received or paid. So keeping all these fixed costs same, the client needs to keep in mind that the spot exchange rate is not played with when negotiating with the bank.

What is the spot exchange rate?

In currency markets, the exchange of one currency into another happens at a specified rate. In a foreign exchange transaction, an agreement is made between a buyer and a seller to exchange one currency for another at an agreed price to be settled on a specified date, this is called the spot exchange rate. The contracted price for the transaction would be settled in two trading days. When they say the currency markets are volatile, it is the spot exchange rate, which is being referred to, which fluctuates within seconds.

Spot representation

For a spot transaction the specified date is the spot date, which is two business days from the transaction date (T). Thus spot date is represented as T+2. If the settlement is same as the transaction day, then it’s called a cash transaction (T). Similarly, if the settlement date is the next working day, it’s represented as T+1.

Since the markets trade at spot prices its important in understand the terminologies used around that. The price quoted in the currency market is different for buyer and for sellers. It is called as the bid and ask price. Ideally for every buyer of a currency, it is marked up a few paisa and is the ask price while for selling it is marked down and is called as bid. Now the spot is the mid price of bid and ask quotes.

Factors affecting the spot exchange rate

 While the major factors which make the spot exchange rate move are the demand and supply for the currency pairs. But the demand and supply is based on certain fundamental and technical factors. Fundamentally,

  • the inflation rate and interest rate prevailing in the economy
  • foreign capital movement within the system
  • current account and balance of payments
  • government debt
  • foreign exchange reserves
  • geo-political factors

These are a few factors amongst others which affect the change in the spot exchange rate.

Technical factors like the trend and charts along with other indicators help in determining or striking stop loss levels move the spot market considerably sometimes. It is key to understand these factors before making big volume conversions.

Will the bank share the spot rate?

As discussed earlier higher volumes generally demand the bank treasury to share the currency markets rate along with the bank margin. Sometimes bank margins as low as half a paisa is charged for huge recurring volumes. While many a times, the bank charges as high as a rupee from retail clients. To get closer to real-time rates, one often seeks assistance from advisors and foreign exchange information providers to get closer to the markets. Online screens are often installed to keep a check on the currency movements. Currency trend is noted and forex hedging strategy is formulated to ensure benchmarks of all transactions are adhered to. Thus when supported with an information provider, banks tend to fix other things and negotiate on the prevailing spot rate if any different. This lets the corporate focus on forex risk management than just information discussion. More fruitful techniques are evolved depending on risk profile of the client.

Apart from the USD/INR rate, Indian banks still tend to play around with the cross currencies like EUR/USD and GBP/USD. Keep the information at your end while talking to the bank/currency exchangers and don’t make them play with your hard earned money.

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