Spot exchange rate : What is it?

Spot exchange rate : What is it?

24 Feb 2020 05:08 PM
 

With the growing opportunities for international business due to technology advancement, availability of finance facilities, and a reduced barrier to market entry, the dealings of organisations with foreign currencies have become prominent. In the quest to cast a wider net of international transactions for their business, corporations and individuals are discovering the importance of understanding the forex market's nuances and seeking professional support. For businesses that witness significant forex currency involvement, it becomes necessary to understand the potential forex risk and relevance of the correct knowledge regarding spot exchange rates, forward exchange rates, forward contracts, etc. to reduce forex risk and capture favourable market opportunities. This understanding serves two purposes - one is the ability to make informed forex decisions by becoming familiar with the dynamics of real-time forex rates vs the rates quoted by banks - while the other is utilising favourable market movements. 

When one understands the spot exchange rate, it helps businesses, especially smaller enterprises, to figure out that the exchange rates quoted to them for their forex transactions differ significantly from that of a larger corporation with a larger trade magnitude. The exchange rate that you get for your forex transaction can be influenced by its size, with sizeable volume attracting better rates due to more negotiating power. There is a high probability that you might be overcharged when buying foreign currency and underpaid due to lowered forex rates while selling foreign currency. The overcharging by financial institutions like banks is attributed to retail clients' smaller transaction value.

Due to a situation like this, there is a gap between the expectation of getting currency conversions quotes that are similar to the rates used in the forex market's currency conversions, and the reality of incurred overcharges and added profit margins in the quoted rates. Besides this, the additional charges an individual or company might need to pay on their forex transactions include the documentation charges for processing and service provider's margins. Thus, it becomes imperative for individuals who regularly deal with forex to understand that the spot exchange rate is not what they are operating with when negotiating with their banks. Since any transaction in foreign exchange market is influenced by the forex rates, you still might be missing out on enhanced savings by not exploring better options with expert's help in terms of rates quoted by banks.

What is the spot exchange rate?

The foreign exchange spot market can be very volatile where, in the short term, the rates are  influenced by speculation and technical trading whereas in the long term various factors like economic conditions and interest rate differentials, etc. unanimously drive the rates. The exchange rate quoted for immediate delivery/settlement of a contract is the spot exchange rate. The spot value date refers to the date of settlement of the spot contract.

The exchange rate for a currency pair for delivery on the spot value date is the spot rate. In general and simpler terms, it symbolizes the price at which the buyer and seller value the foreign currency asset right now.  In the forex market, the spot exchange rate is the current rate applicable to the trade completed "on the spot" which means the completion of trade as soon as possible. The foreign exchanges executed at the spot rate are delivered (or settled) on the second business day from the transaction date; therefore, the spot date is represented as T+2 business days. The exception to this is USD-CAD which is settled on the next business day. 

For an increased understanding of spot exchange rates, it is also essential to understand the factors that affect them.

  1. The changes in the domestic currency value due to relative changes in the inflation rates of different countries result in exchange rate fluctuations. 
  2. An increase in the interest rate brings a larger flow of investment in the country and reduced outflow of investments, thereby strengthening the country's currency.  
  3. In the shorter run, demand and supply of foreign currency plays a huge influencing role in exchange rates' movements. Direct pressure is exerted on the exchange rates due to excess foreign currency flows out of the country and vice versa. 
  4. The stability and instability of a country's political scenario can affect the strength of a nation and in turn on the domestic currency exchange rate. Changes in government policies and the general political situation can facilitate a position of investment inflows into the country, thereby strengthening the domestic currency.

Difference between the spot rate and forward rate

The spot rate is the exchange rate for a currency pair for a delivery on the spot value date. On the other hand, the forward rate is the exchange rate for a currency pair for delivery on a specific future date (beyond the spot value date). Forward foreign exchange contract is an agreement to buy or sell a currency at a predetermined future date at a specified currency exchange rate. A better understanding of the spot rate can be established through an example. Suppose that party A makes a spot transaction in the forex market. Party A purchases 1,000,000 EUR versus the USD wherein he is quoted by the broker at an exchange rate of 1.2162, which is the prevailing spot rate for that currency pair. Upon entering a spot trade by party A by deciding to deal at the quoted exchange rate, the trade would be scheduled for delivery in 2 business days. On the delivery date, Party A would purchase 1,000,000 EUR by selling 1,216,200 USD (1,000,000 x 1.2162). However, in the case of the forward foreign exchange, the spot exchange rate would be adjusted by considering the interest rate differential between the currencies involved in the trade and the time gap between forward delivery date and spot delivery date. These adjustments in foreign currency exchange rates due to the differentials in interest rates are called forward premiums or forward discounts. 

To understand the differences between the rate quoted by the banks compared to the prevalent market rates, the access to relevant real-time market information, whether from professional guidance or other sources becomes absolutely necessary. This enables corporations and individuals to minimize losses related to unfavourable forex rates, especially for the smaller companies with forex dealings of lesser magnitude.  Myforexeye services allow our clients to manoeuvre these loopholes since our team's expertise and experience facilitate better exchange rates for you from your banks. Our services encompass better quotes for all your forex transactions through transaction process outsourcing, forex risk management, access to live forex rates, etc. as well as cheap international trade funding alternatives through buyer's credit, supplier's credit, export factoring, LC bill discounting, etc. These services collectively as well separately simplify the forex journey of individuals and corporates while enabling enhanced savings. Everyone might not necessarily have the right knowledge, and available time to understand the forex market's nuances to increase the value they are extracting from their forex transactions. Myforexeye services empower them by letting our clients leverage our expertise in accessing better rates so that they can put emphasis on other crucial aspects of their business. Non-optimal forex rates should not shrink all the hard work that goes behind the scenes in bringing the desired revenue and profits of your business.  

Conclusion

Myforexeye provides the solution for all the forex needs of organizations irrespective of their scale and individual forex enthusiasts by making their forex transactions simpler, faster, and more cost-effective. Our Specialized team is backed up with advanced technology and experienced professionals' expertise reinforced by our transparent streamlined processes. Our user-friendly web portal and mobile app empower users to make savings and provide an insight into real-time rates and best quotations from banks to equip you with the best possible options. Our clients have access to expert guidance and consultation on a transactional basis to mitigate forex risks. 

Speak to one of our specialists to acquire a detailed understanding of Myforexeye forex services.

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