What Does the Forex Spot Rate Mean?
The forex spot rate refers to the current exchange rate at which a currency pair can be exchanged. It represents the prevailing rate provided by a forex broker for any given currency pair. In forex trading, especially when dealing with online retail brokers, this is the rate most traders rely on for transactions.
Main Insights
- The forex spot rate is the regularly published continuous quote of exchange rates for all currency pairs.
- The spot rate differs from the forward or swap rate.
- The spot rate is not discounted for the delay in delivery, which gets added to the overnight rollover credit.
Breaking Down the Forex Spot Rate
The forex spot rate is the most frequently quoted price for currency pairs and serves as the foundation for the majority of transactions in the forex market, such as individual forex trades. It is more widely available than rates for forward exchange contracts (FECs) or forex swaps. Unlike the forward rate, the spot rate reflects the current value of one currency in relation to another, as opposed to a future value.
In 2019, the global forex spot market saw a daily turnover exceeding $6.6 trillion, surpassing the equity and bond markets in size. Rates are determined through continuous, real-time quotes provided by a select group of major banks that trade at the interbank rate. These rates are then published by forex brokers globally.
Spot rates do not account for forex contract delivery, which is typically not a concern for most retail forex traders. However, brokers manage currency futures contracts to support their trading operations. These brokers must roll over contracts regularly, either monthly or weekly, and they pass the associated costs onto their customers.
To manage their risk while ensuring liquidity for customers, forex dealers often use the bid-ask spread and adjust rollover credits or debits (depending on whether a trader is long or short) to cover these expenses.
The Role of Delivery in Forex Trading
The standard delivery time for a forex spot transaction is T+2 days. If a counterparty wants to delay delivery, they would need to enter into a forward contract. Typically, it is the forex dealers who manage this process. For instance, 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 those in the U.S., the rate will be adjusted to reflect this difference. As a result, if a dealer or counterparty wants to hold EUR and short USD for an extended period, it will cost more than the spot rate. It’s important to note that spot rate delivery times can vary for different currency pairs.
Although the forex spot rate typically requires delivery within two days, this is rarely the case in actual trading. Retail traders who hold positions for longer than two days will have their trades “reset” by the broker, meaning the trade is closed and reopened at the same price just before the two-day deadline. However, when the currencies are rolled over, a premium or discount is applied in the form of an adjusted rollover fee. The size of this fee is determined by the difference in interest rates, which is reflected in the short-term FX swap.
The Role of Forward Rates in Forex Markets
Unlike a spot contract, a forward or futures contract involves agreeing to terms on the current date with delivery and payment occurring on a specified future date. A forward rate, in contrast to a spot rate, is used to quote a financial transaction set to take place in the future and represents the settlement price of a forward contract. The forward rate can be calculated from the spot rate, depending on the asset being traded. Once the spot rate is determined, it is adjusted for the cost of carry to calculate the future interest rate, which aligns the total return of a longer-term investment with the strategy of rolling over shorter-term investments.
