What is a spot rate?
Interest rates, commodities, securities, currencies, and the likes have prices. But when you say price, it may be vague because it is a general term in trading and investments. Price may mean a lot of things. Hence, we need to specify what kind of price that we are talking about. Today, we will tackle spot rates, also known as spot price, which refers to a price quote that can be used as an immediate settlement for any asset we mentioned earlier. Hence, the asset’s current market value is ready for prompt delivery during the quote situation. The value will always depend on both the buyers and sellers and how much they are willing to buy and accept for their assets, respectively. They will always consider many factors, such as the asset’s current market value and how much more it can increase or decrease in the future.
Securities and commodities spot prices tend to be the same in many parts of the world, even when they are sensitive to time and place. You may have already noticed this when you compare exchange rates. On the other, this does not apply to futures and forwards prices. Their price is agreed upon for the asset’s future delivery.
The spot rate in different asset classes
Different assets have different spot rates, and we can check them out on sources like Bloomberg, Reuters, and Morningstar. Aside from these sources, we can find this information in the news. Let us talk more about few assets with spot rates in our enumeration below:
- Currencies. Forex spot rates are also popular as a benchmark, outright, or straightforward rate. People and businesses who want to engage in currency transactions and their demands majorly impact forex transactions. In fact, forex traders themselves also influence transactions.
- Commodities. Commodities refer to gasoline, cotton, gold, copper, propane, coffee, wheat, lumber, and the likes. They are raw materials that are necessary to make a finished product. These assets also have spot rates, and they depend on the supply and demand for them.
- Bonds. Bond spot rates depend on zero-coupon rates.
But what is a forward rate?
The spot rate is an essential key in knowing the forward rate. The forward rate refers to a price that two people agreed upon for a future financial transaction. We know that we can expect the future value of assets like commodities, securities, and currencies with their current value as a basis. Aside from that, it also depends on many factors, such as risk-free rates and the time remaining until the contract’s maturity. Hence, futures price, risk-free rate, and remaining time before maturity are three things that can help one estimate an unknown spot rate.
Now, we return to the role of the spot rate in forwards rate. Spot settlement refers to the fund transfer that completes a spot contract transaction. Now, this happens in one or two business days starting from the trading date, which we can also call the horizon. The spot date, then, is the settlement date. The initiation and settlement will be completed at the agreed-upon spot rate no matter what happens in the market between the transaction date and the settlement date.
Finally, we also have:
Spot rates are also involved with futures contract prices. The difference between theses two may be crucial. Futures prices may either be contango or backward. There is more to these that traders should know to become more profitable in trading.