Forex Spot Rate
Tue, Apr 15The forex spot rate (or FX spot rate) refers to the cost in one currency to purchase another currency for immediate delivery. There is no single “spot” rate available.
When initiating a trade, FX traders receive two rates (or prices). They can choose to buy at the specified ask price (“go long”) or sell at the indicated bid price (“go short”). The “exchange rate” for a currency pair typically denotes the “mid” price, which is the average of the bid and ask prices. The exchange rate for a spot FX transaction is usually higher or lower than the mid price, depending on whether the transaction is executed at the bid or ask price.
While major participants in the interbank FX market can negotiate and influence market bid and ask prices through their trading activities, smaller participants often act as price takers. For instance, businesses and individuals trading FX through intermediaries like banks or brokers may encounter a wider quoted spread between bid and ask prices compared to the interbank market spread.
“Spot” Does NOT Mean “Immediately”
The term “spot” in the context of an FX transaction signifies “on the spot.” In everyday language, it implies needing to produce something instantly. However, in the FX market, “on the spot” refers to the settlement date. This indicates that traders do not need to possess enough currency to settle a spot FX transaction immediately upon execution. The “settlement” or “value” date is when the funds are physically exchanged, which typically occurs two business days after the transaction or “trade” date, denoted as “T+2.” Some currency pairs may settle sooner; for example, the settlement date for USD/CAD and USD/TRY is one business day after the transaction date, or T+1. The Chinese yuan and Russian ruble can settle on the trade date, or T+0, although T+1 settlement is more common. “Business days” exclude Saturdays, Sundays, and legal holidays in either currency of the traded pair.
Rolling Spot FX
Even though spot FX trades always have a settlement date, most are not physically settled. Traders generally aim to profit from exchange rate fluctuations rather than acquiring large amounts of currency. To avoid physical settlement, traders typically “roll over” transactions on the settlement date. They close the transaction at the closing price and re-open it at the next day’s opening price, effectively extending the settlement date by one day. The difference between the closing and opening prices is recorded as profit or loss. Many FX brokers automate this process for their clients.
Simultaneously entering into buy and sell trades with a one-day settlement difference is a common method for rolling over positions, known as “tomorrow next” or “tom-next.” Although the two trades involved are spot trades, the swap price is determined using interest rate differentials, similar to a forward contract.
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