What’s it: Spot exchange rate, spot rate, is the exchange rate of the currency for immediate delivery. The standard settlement date for this transaction is (T + 2) after the trade date.
In theory, the delivery should be immediate, a few seconds after the transaction. However, currency market conventions often take up to two days for a transaction to be completed. For some exchange rates, such as USD / CAD, USD / PHP, USD / RUB, the settlement date is earlier, i.e. T + 1.
Where to find spot exchange rate data
You can even use Google to find spot exchange rates. Just enter the currency keyword in the Google search bar using the standard ISO three-letter code. If you want to find, for example, the exchange rate between rupiah (IDR) and US dollar (USD) in terms of IDR / USD, you can simply write “1 USD in IDR“.
Distinguish the spot rate from the forward rate
In simple terms, the spot rate is how much you get when you exchange your money into another country’s currency. Meanwhile, the forward rate or forward rate is when you agree with another party to exchange your currency for that party’s currency in the future.
For example, you want to exchange rupiah with a partner who provides US dollars. You take out a forward contract and agree on an exchange rate of IDR14,000 per US dollar within the next year. After one year, you hand over IDR14,000 to get 1 US dollar. The spot rate may have moved away from IDR 14,000 per US dollar by that time, for example, to IDR13,000 per USD. In this case, you lose because the spot rate is lower than the forward rate; hence, you have to spend more dollars to get US dollars.
The forward rate is simply a function of the two currencies’ relative interest rates and the spot rate. You can calculate the forward rate with the following formula:
Forward rate = Spot rate x (1 + Domestic interest rate) / (1 + Foreign interest rate)
Let’s take a simple example. If the rupiah spot rate per USD is 14,000 and the rupiah and USD interest rates are 7.5% and 0.4% per annum, respectively. Then the calculation of the IDR / USD forward rate is:
Forward rate = IDR14,000 x (1 + 7%) / (1 + 0.4%) = IDR14,920 per USD
Factors affecting the spot rate
The spot foreign exchange market is highly liquid and highly volatile. In the short term, the exchange rate is influenced not only by market fundamentals (supply and demand) but often also by the news and other sentiments.
However, in the long run, exchange rates are generally influenced by a combination of differences in interest rates and a country’s economic fundamentals.
Central banks sometimes intervene in the market. They do this by buying or selling local currency or by adjusting interest rates. The intervention aims to reduce fluctuations in exchange rates, bringing uncertainty in the economy and economic decision-making.
In general, countries with large foreign currency reserves are better positioned to intervene in the market. They are relatively resistant to attacks by forex speculators.
The more enormous reserves make the intervention more credible. Conversely, fewer reserves mean a lower capacity to influence domestic currency exchange rates.
How the spot market works
The spot rate is the best indicator to reflect today’s actual value when you want to exchange money. When converting from rupiah to US dollars, the spot rate tells you how much rupiah you have to spend to get 1 US dollar.
For example, Indonesian companies must pay USD14 million to US companies today, 17 December 2019. How many rupiahs companies in the spot foreign exchange market have to convert to get the necessary US dollars.
From google.com, we got 1 USD = 14,015.66 rupiah on December 17, 2019. The exchange rate is based on mid-market quotes.
From this information, we know that to get 14 million US dollars, the company had to exchange IDR196,219,240,000 in rupiah.
There are several ways for a forex trader to be able to make spot transactions. Today, transactions have become more comfortable with the advent of online trading systems.
The exchange takes place between the two parties directly. That eliminates the need for a third-party intermediary. Also, an electronic intermediary system allows participants to make their trades via an automatic order matching system.
Traders can also use electronic trading systems through single or multi-bank transaction systems. Also, trading can be through a broker or by telephone with a foreign exchange broker.
For most spot foreign exchange transactions, the settlement date is two business days after the transaction date. Both parties agree on a price on the transaction date and the number of currency units to be exchanged. The parties also agree on the transaction value in currency and settlement dates. If both currencies are to be sent, the parties exchange bank information.
Forex market participants
The spot exchange rate is formed through the supply-demand for foreign currencies globally on the foreign exchange market. It is the largest and most liquid market globally, with trillions of dollars changing hands every day. Because it is liquid, the spread between the buy and sell prices is very narrow.
Among the currencies that are most actively traded are the US dollar and the Euro. Both are used in many countries in international transactions.
Trading takes place electronically around the world between large and multinational banks. Other active participants in the forex market are corporations, mutual funds, hedge funds, insurance companies, and government entities.
Transaction motives vary, given the diverse composition of participants. They may transact for import payments, short-term and long-term investments, loans, and even for speculation.