Spot Rate | Definition, Role In Financial Markets
According to the International Monetary Fund (IMF), a price is the amount of money that a buyer gives to a seller in exchange for a good or service. Prices come in all shapes and sizes, depending largely on the asset class in question.
Commodities, shares, crypto and currency are all subject to pricing. For instance, currencies are priced relative to one another in terms of an exchange rate. Assets such as commodities, shares, or crypto are subject to an interest rate, forward rate, or a spot rate.
In this article, we'll examine the spot rate, spot markets and how spot pricing differs from futures and forward pricing.
What Is A Spot Rate?
A spot rate, also referred to as spot price, is the price of an asset that is subject to instantaneous payment and delivery. Common items such as gasoline, groceries or event tickets are subject to spot rates; one pays the current spot price and immediately receives the asset.
In other words, the spot rate is the price where an asset can be instantly exchanged. Spot rates may be denominated in any fiat currency, from euros (EUR) and British pounds (GBP) to the Chinese yuan (CNY). Many global commodities such as crude oil, wheat and gold are subject to a spot price local to the world's reserve currency, the US dollar (USD).
Spot Rates Vs Derivatives Pricing
The US Securities and Exchange Commission defines financial derivatives as follows:
"Financial instruments whose performance is derived, at least in part, from the performance of an underlying asset, security, or index."
Essentially, a financial derivative is a product that is based on an asset. Two of the most popular are futures and forward contracts:
- Futures Contracts: A futures contract is a legally-binding document that defines the exchange of an asset for a price at some future point in time. Futures contracts are subject to an expiration date and are priced with respect to the underlying asset's valuation at expiry.
- Forward Contracts: A forward is an agreement to buy or sell an asset on a specific date in time at a predetermined price. Forward contracts are used to mitigate volatility risk facing forthcoming transactions.
Futures and forwards are priced with the future value of an asset in mind. They are subject to a deferred settlement date, which can be days, weeks, months or years away from contract signing. The prices of these products depend on market sentiment and are subject to fluctuation over time.
Conversely, buying and selling an asset on a spot market is immediate. One pays the spot rate and receives instant delivery of said asset. There is no future settlement date or contract delivery to contend with. The spot rate represents what the asset is worth now, not at some future point in time.
Spot Prices And The Financial Markets
A spot market is one where assets are subject to immediate delivery in return for the current spot rate. In contrast to the trade of derivatives, these markets offer immediate settlement. Many assets are traded on both derivative and spot markets as each type of transaction has a collection of unique benefits.
Below, we'll look at a few prominent types of spot markets.
Commodities trading has been an essential part of commerce since the dawn of human history. Whether buying or selling foodstuffs, securing energy sources, or storing wealth, the spot commodity trade is a vital element of global finance. Here's a quick look at a few key spot commodity markets.
Ag products are frequently bought and sold on spot markets. Most of these venues are local, offering instant livestock, grain and oilseed delivery. The ag spot markets play a key role in establishing the basis, the difference between spot and futures prices. This is an important factor that is considered when pricing regional exports.
According to the Intercontinental Exchange (ICE), about 40% of the world's crude oil is traded on the spot markets. Although benchmark pricing is related to the futures trade of West Texas Intermediate (WTI) and North Sea Brent (Brent) crude oil, the spot trade of oil is a major component of the global valuation model.
Spot gold is one of the largest markets in the world. Individuals buy gold bars, coins and ingots with the intent of quickly assuming physical delivery. Financial information vendors such as Bloomberg and Reuters list the current spot rate for gold (XAU/USD) for public reference. The largest spot gold vendor in the world is the American Precious Metals Exchange (APMEX), which conducts business online.
Of all the world's capital markets, the foreign exchange market (forex) is the largest. In its 2019 Triennial Survey, the Bank of International Settlements (BIS) measured average daily forex turnover to be upwards of US$6.0 trillion.
The Forex Market
The forex market is a decentralised over-the-counter (OTC) venue where participants buy and sell foreign currency pairs. On a daily basis, millions of people from around the globe look to profit from short-term and long-term forex strategies. These transactions are completed using the currency pair spot exchange rate. Upon a trader buying or selling an FX pair, the trade is executed instantly and delivery is made according to the current spot valuation.
Since the launch of Bitcoin (BTC) in 2009, cryptocurrencies have become an exceedingly popular asset class. Although there are crypto futures and CFD derivatives products, a lionshare of trade is conducted on OTC spot markets.
Cryptocurrencies traded on spot markets are subject to immediate payment and delivery. This may be done in several ways:
- Exchanges: Digital currency exchanges such as Coinbase, Kraken or Binance offer buyers and sellers the opportunity to trade crypto products. Transactions are settled in minutes, not business days.
- Peer-to-Peer: Private transactions between parties can be arranged. Spot market rates are often the basis for these types of activities.
- OTC Markets: Individuals can buy and sell crypto with vendors outside of a formal exchange in an over-the-counter capacity.
A spot rate is the price at which an asset may be immediately bought and delivered. Contrary to a derivative product such as a futures or forward contract, spot transactions are conducted instantly. Upon a buyer paying a seller the spot price, delivery of the asset is made. This is contrary to derivatives, which may feature a settlement date of one year or more.
Spot markets comprise a large portion of the global economy. Commodities, currencies and crypto are asset classes that conduct enormous business in an OTC or spot capacity. These transactions range from buying foodstuffs at a local farmer's market to trading cryptocurrencies on an online exchange.
At the end of the day, the spot rate is an important benchmark of an asset's value. No matter the region or market, the spot rate has a profound influence on the worth of a good or service.
FXCM Research Team
FXCM Research Team consists of a number of FXCM's Market and Product Specialists.
Articles published by FXCM Research Team generally have numerous contributors and aim to provide general Educational and Informative content on Market News and Products.
Retrieved 01 Aug 2022 https://www.imf.org/external/pubs/ft/fandd/2013/12/basics.htm
Retrieved 01 Aug 2022 https://www.investor.gov/introduction-investing/investing-basics/glossary/derivatives
Retrieved 01 Aug 2022 https://www.ndwheat.com/buyers/marketinformation/
Retrieved 01 Aug 2022 https://www.theice.com/why-the-world-needs-benchmarks-and-characteristics-of-benchmarks
Retrieved 01 Aug 2022 https://www.apmex.com/gold-price
Retrieved 01 Aug 2022 https://www.bis.org/publ/qtrpdf/r_qt1912f.htm
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