Spot Rates vs. Forward Rates

In the forex market, understanding the difference between spot rates and forward rates is crucial for anyone involved in currency trading or international finance. Spot rates represent the current exchange rate at which one currency can be traded for another for immediate delivery, typically within two business days. Forward rates, on the other hand, are agreed-upon rates for a currency exchange that will occur at a future date, allowing businesses and investors to hedge against currency risk over time.

While spot rates reflect the current market conditions and immediate supply and demand dynamics, forward rates are influenced by interest rate differentials and expectations about future currency movements. Together, these two rates help participants manage exchange rate exposure, speculate on future currency trends, and make informed decisions in international transactions. Understanding the interplay between spot and forward rates provides insights into both short-term and long-term currency market dynamics, making it an essential area of knowledge in forex trading and hedging strategies.

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What is a Spot Rate?

Among currency traders, the spot date of a typical foreign exchange deal is the day when it is normally settled. The term arises from the phrase "on the spot" since the trade should be consummated as soon as is practically possible. The spot value date is generally 2 business days from the transaction date.

The notable and lone exception to this 2-day delivery rule is the USD/CAD currency pair that commonly trades in the forex market for delivery in just 1 business day from the transaction date. This is sometimes referred to as trading for “value funds” rather than for spot price to make a clear distinction between the value dates that settlement of the trade is expected to occur on.

The spot value date is also the date when the market quoted exchange rate is not altered based on the interest rate differential between the currencies involved. A spot rate is therefore the exchange rate for a currency pair for delivery on the spot value date.

All currency pairs are quoted and trade in the forex market for delivery on the spot value date. This is also known as “trading for value spot.”

Spot Rate Example

Say that you make a spot transaction in the forex market by purchasing 100,000 EUR versus the USD. Your broker or market maker quotes you an exchange rate of 1.2162, which is the prevailing spot rate for that currency pair.

If you decide to deal at that spot exchange rate, you enter into a spot trade that would ordinarily be scheduled for delivery in 2 business days. Thus, if today is Monday and no bank holidays occur this week, the spot trade will settle on Wednesday.

What is a Forward Rate?

A forward rate is the exchange rate for a currency pair for delivery on some value date other than the spot value date. Since a forward or “forward outright” transaction does not go to delivery on the spot value date, its exchange rate is generally known as its forward rate. A “short date forward” involves settlement before the regular spot value date.

The forward exchange rate needs to be adjusted from the prevailing spot rate based on the interest rate differential between the currencies involved and how far the forward delivery date is from the current spot delivery date. In practice, traders can simply add or subtract the appropriate number of swap points quoted by forward traders from the spot rate to get the forward rate.

Swap points are sometimes also known as forward pips. They are calculated by forward traders to take into account the difference in market interest rates on deposits in the traded currencies in a currency pair.

A trader who has purchased the higher interest rate currency will receive swap points for doing a forward rollover that will add to and hence improve their position’s overall exchange rate. A trader who sold the higher interest rate currency will pay away swap points to rollover their position to a future date. Performing this rollover will subtract from their position’s exchange rate and give them a worse rate.

Forward Rate Example

You can use the following equation to compute the forward rate:

Forward Rate= spot rate+ swap points (converted to exchange rate terms)

In practice, you will get a forward outright rate by asking for a spot rate and swap points from your broker or market maker and then applying the above equation to compute the forward rate. Since swaps are generally quoted in points or pips, you’ll need to convert that to normal exchange rate terms.

If you’re buying a currency pair, then you will trade at the offer side of the spot rate and the swap points. If you are selling the pair, you will trade at the bid side of the spot rate and the swap points.

The 2 interest rates used in calculating the swap points are the prevailing Interbank deposit rates for a deposit concluding on the forward delivery date for each currency in the pair. The London Interbank Offered Rate (LIBOR) for a currency can be used as an estimate. The spot rate is the exchange rate generally quoted in the forex market.

Now consider an example where you wish to compute the forward exchange rate for GBP/USD given a spot rate of 1.3685 and 3-month swap points of +10.3. Note that those swap points convert to 0.00103 in exchange rate terms since 1 pip equals 0.0001 in the GBP/USD exchange rate.

GBP/USD 3 month forward rate = 1.3685 +0.00103 = 1.36953

That means your all-in exchange rate for buying GBP/USD with a delivery date 3 months forward would be 1.36953.

Where to Find Spot Rates

Several financial market information sources provide spot rate information. These include Bloomberg, Thomson Reuters and Morningstar. Retail forex trader-focused websites like ForexFactory also provide a list of spot rates.

If you plan on trading via an online forex broker, you can also typically display a list of current spot rates using your trading platform. Third-party platforms like MetaTrader 4 and 5 from MetaQuotes provide a watch list of spot rates that updates in real-time. Spot price is an important factor in the currency markets.

Where to Find Forward Rates

Forward rates for a series of standard future delivery dates are typically calculated by traders from spot rates and the swaps to those delivery dates. Forward rates to intermediate delivery dates occurring between standard future delivery dates can then be interpolated in a linear fashion.

Rather than showing forward rates per se, most information sources will instead display spot rates and swaps so that forward outright rates can be calculated by the trader. Several financial market information sources provide swaps that forex traders can use along with spot rates to compute forward rates.

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