What Is a Spot Rate in Foreign Exchange?
Experts have perhaps advised you to check the spot rate before exchanging currencies, and you are wondering, “What is a spot rate?” The truth is, foreign exchange rates can be very confusing. You’ll come across terms like the “mid-market rate” or “interbank rate.”
Before you make any international funds transfer or exchange currency, you need to understand the different exchange rates. Notably, the spot rate plays a significant role during transactions. It determines the amount of money you will get after an exchange.
In this guide, we explore the basics of a spot rate, including how it operates and how to execute it. You’ll also learn why the spot rate is such a big deal in foreign exchange.
What is Spot Rate in Foreign Exchange
When it comes to foreign currency exchange, a spot rate is the current exchange rate at which a specific currency can be sold or bought at a particular time. It’s the open market price you pay to buy another currency. In other words, it’s the “right now” exchange rate.
Generally, the global foreign exchange market regulates the spot exchange rates. Many countries, organizations, and currency traders transact trillions of currencies on the market every day. That makes foreign exchange the most liquid market worldwide.
If you see an exchange rate described as a spot rate, you can rest assured that it’s the actual exchange rate. It’s always a good idea to double-check to ensure you are getting a fair rate and to avoid getting ripped off your money.
Note that cash delivery after spot currency exchange transactions usually occur within two business days after the transaction date. The spot investments involve big financial transactions in international markets, constituting 43 percent of total forex transactions.
How Spot Rates Get Determined in the Foreign Exchange Market
A spot rate is the actual exchange rate that banks or other currency exchange providers use when selling currencies in the global currency markets. Unfortunately, most banks may not disclose the spot rates to their customers due to their hidden fees.
Most currency exchange providers use the mid-point between the ask and bid prices of a currency to calculate the spot rate in forex trades. This is why it’s known as the mid-market rate. However, it can be tricky to keep up with the spot rate as it fluctuates.
Since exchange rates tend to move up and down throughout, it will be tricky to calculate the spot rate yourself. The most convenient way to keep up with the spot rate for your currency pairing is by checking the rates using KnightsbridgeFX’s currency converter. You may also find the interbank exchange rates using Google currency converter.
Why Spot Rate is a Big Deal in Foreign Exchange Market
A spot rate can be very beneficial as it eliminates guesswork out of foreign currency exchange. It provides a sense of operational security to funds in the short term. When you know the spot rate, you can confidently make international fund transfers.
When you are making international fund transfers or paying an invoice overseas, the spot rate will be crucial. It’s a significant factor that determines how much your money is worth when you convert it to another currency.
You should be aware that the exchange rates that banks or currency exchange services offer are not the spot rates. Most of these financial institutions will inflate exchange rates to capture their profit margin. That makes banks one of the most expensive options.
Beware of the “no commission” or “fee-free” currency exchange adverts. Some currency exchange providers may claim to offer fee-free services even if they have hidden fees. The truth is, the currency providers make profits somewhere.
Before you choose a bank or currency exchange service to use, check the exchange rates they offer. There may be upfront fees or hidden charges, making the service costlier.
The Difference between Spot Rates vs. Forward Rates
The spot rate is the “right-now” exchange rate of a currency against another currency at a specific time. But what if you are not ready to exchange your money immediately?
Perhaps you got a lucrative deal in Europe, but you are not prepared to make payments yet. If you are concerned that the foreign exchange rates will worsen in the future, the forward rates can be the perfect solution. So how do the forward rates work?
Some of the uncontrollable factors that may cause the exchange rates to increase are political instabilities, seasonal weather, or market trends. A forward rate allows clients to lock in the current foreign exchange rate for future transactions at the agreed date.
Note that the contract is binding but can be very helpful to some customers.
How to Execute Spot Foreign Exchange Transactions
With the advent of online forex trading systems, currency exchange traders can execute spot exchange transactions in many ways.
- Direct Execution: Currency exchange involves two traders without the need for a third party. They may execute transactions through telephone communication or electronic dealing systems, such as the Reuters conversational system.
- Electronic Broking Systems: Allows foreign exchange traders to trade through automated order matching systems. An excellent example of an electronic broking platform is the Reuters Matching 3000 system.
- Electronic Trading Systems: Allows traders to execute their foreign exchange transactions through either a single-bank trading platform or a multibank dealing system. The trading systems are software programs tailored for forex traders.
- Inter-Dealer Voice Broker: Allows an individual to execute a foreign exchange trade through conversation with a foreign exchange broker over the phone. The broker acts as a financial intermediary to facilitate transactions between traders.
When performing a currency exchange or international transfer using your currency’s spot rate, you should get the lowest exchange rate. Now that you understand what a spot rate is, remember to check out all the fees and other costs involved to save more money. At KnightsbridgeFX, we offer consistent bank-beating rates to all our clients.