What is Spot Rate?

What's the spot rate ?

For immediate settlement of trades in currencies, securities or commodities, there is an agreed price. This price is known as the spot rate, or the spot price of the commodity. The spot rate is defined as the current market price at the time of an asset's quote. Spot rates are based on the amount a buyer will pay and how much a seller will accept. It is usually influenced by a variety of factors, including the current market price and its expected future value.

Simply put, spot rate is the price at which a particular asset is available in the market. Spot rates can fluctuate quite often and in some cases, even swing dramatically. It can be influenced by headlines about the asset and any significant events that impact investor sentiment. This makes it volatile.

Understanding Spot rate meaning

Spot rate is affected by requests from individuals and businesses who wish to transact in foreign currencies or forex. Forex is also known as the outright rate (or benchmark rate), or simply rate. Other than currencies, other assets can also have spot rates. These commodities include gasoline, crude oil cotton and coffee, as well as other commodities such as lumber, bonds, gold, timber, and wheat.

Spot rates for commodities are determined by both the demand and supply of these items. Bond spot rates have a zero-coupon interest rate. Spot rate information can be accessed from a variety of sources that traders can use for making strategic market moves. Spot rate values are often covered in the news, especially for currency and commodity prices.

Spot rate Example

To illustrate how spot rates work, let's say it's September and that the wholesaler is responsible for the delivery. The wholesaler will pay the spot rate to the seller in order to have the fruit delivered within two days. Let's say that the wholesaler wants the fruits to be available in stores by the end of January. However, they also believe that prices will rise due to wintertime supply and demand. The wholesaler won't find it profitable to spot buy the commodity of fruits because the risk of them spoiling is greater.

The fruits won't be needed until January 31st so spot prices don't seem necessary. A forward contract is better in this situation. This is how spot prices are used in market transactions. The above example shows that a physical commodity is being taken out for delivery. This type of transaction is usually executed with a traditional or futures contract, which refers to the spot price at the time it was signed.

However, traders are often reluctant to accept the risk and labor associated with physical delivery of commodities. They use options contracts, which give them positions at the spot rate for the currency pair or commodity, to counteract this risk.

Spot rate v Forward Rate

Spot settlement is the process of settling a spot rate. It involves the transfer of funds, thereby concluding the spot contract's transaction. This usually occurs two days after the trading day. This is known as the post date. The date of settlement between buyer and seller of the spot contracts is called the post date. No matter what happens in the market between settlement and the closing date, both sides will follow the agreed-upon spot rates.

This is why the spot rates are often used to calculate what's called a "forward rate". The forward rate is the security price at the time of their future financial transaction. The future value of any security, commodity or currency is determined by its current value, the risk-free interest rate and the time before the spot contract matures. With these three measures, traders are able to extrapolate the spot price of the security, which is not known to them.

Conclusion

Spot rates are the price of security that traders quote. It fluctuates with market developments. It can also be used to determine a security's forward price.