What Is the Forex Spot Rate?
The Forex spot rate is the current exchange rate at which a currency pair can be bought or sold. It is the prevailing quote for any given currency pair from a forex broker. In forex currency trading it is the rate that most traders use when trading with an online retail forex broker.
KEY TAKEAWAYS
1. This rate is the regularly published continuous quote of exchange rates for all currency pairs.
2. The spot rate differs from the forward or swap rate.
3. The spot rate is not discounted for the delay in delivery which gets added to the overnight rollover credit.
Understanding the Forex Spot Rate
The forex spot rate is the most commonly quoted price for currency pairs. It is the basis of the most frequent transaction in the forex market, an individual forex trade. This rate is much more widely published than rates for forward exchange contracts or forex swaps. The spot forex rate differs from the forward rate in that it prices the value of currencies compared to foreign currencies today, rather than at some time in the future.
The global forex spot market has a daily turnover of more than $5 trillion, which makes it bigger in nominal terms than both the equity and bond market. Rates are established in continuous, real-time published quotes by the small group of large banks that trade the interbank rate. From there, rates are published by forex brokers around the world.
Spot rates do not take into account forex contract delivery. Forex contract delivery is oblique to most retail forex traders, but brokers manage the use of currency futures contracts which underpin their trading operations. The brokers have to roll those contracts each month or week and they pass the costs on to their customers.
In this way, forex dealers incur costs managing their risk while providing liquidity to their customers. Most often they use the bid-ask dealing spread and a lower rollover credit (or higher rollover debit depending on the currency pair you hold and whether you are long or short) to offset those costs.
Delivery of Forex Contracts
The standard delivery time for a forex spot rate is T+2 days. Should a counterparty wish to delay delivery, they will have to take out a forward contract. Most of the time it is the forex dealers that have to manage this. For example, if a EUR/USD trade is executed at 1.1550, this will be the rate at which the currencies are exchanged on the spot date. However, if European interest rates are lower than they are in the U.S., this rate will be adjusted higher to account for this difference. So if either a dealer or their counterparty wishes to own EUR and short USD for a period of time it will cost them more than the spot rate. It should be noted that spot rate delivery times are not standard and may vary for some pairs.
Although the forex spot rate calls for delivery within two days, this rarely occurs in the trading community. Retail traders that hold a position for longer than two days will have their trades “reset” by the broker, i.e., closed and reopened at the same price, just prior to the two-day deadline. However, when these currencies are rolled there will be a premium or discount attached in the form of an increased rollover fee. The size of this fee depends on the difference in interest rates, via the short-term FX swap.
Because the spot rate is the rate of delivery with no adjustment for interest rate differential, it is the rate quoted in the retail market. The retail forex market is dominated by travelers who wish to buy and sell foreign currency whether it through their bank or a currency exchange.
Forward Rates
Unlike a spot contract, a forward contract, or futures contract, involves an agreement of contract terms on the current date with the delivery and payment at a specified future date. Contrary to a spot rate, a forward rate is used to quote a financial transaction that takes place on a future date and is the settlement price of a forward contract. However, depending on the security being traded, the forward rate can be calculated using the spot rate. Forward rates are calculated from the spot rate and are adjusted for the cost of carry to determine the future interest rate that equates the total return of a longer-term investment with a strategy of rolling over a shorter-term investment.