Spot rate and Forward rate.
The transactions in the inter-bank market may take place for settlement:
1. on the same day; or
2. two days later; or
3. some day later; say after a month
Where agreement to buy and sell is made on and executed on the same date, the transaction is known as cash or ready transaction. It is also known as value today.
The transaction where the exchange of currencies takes place two days after the date of the contract is known as the spot transaction. For instance, the contract is made on Monday, the delivery should take place on Wednesday. If Wednesday is a holiday, the delivery will take place on the next day; i.e Thursday.
The transaction in which the exchange of currencies takes place at a specified future date, subsequent to the spot date, is known as a forward transaction. The forward transaction can be for delivery one month or two months or three month, etc. A forward contract for delivery one month means the exchange of currencies will take place after one month from the date of contract and so on.
When forward rate is the same as the spot rate for the currency, it is said to be ‘at par’ with the spot rate. But this rarely happens. More often the forward rate for a currency may be costlier or cheaper than its spot rate. The difference between the forward rate is know as the ‘forward margin’ or ‘swap point’. The forward margin may be either at premium or at ‘discount’ . If the forward margin is at premium, the foreign currency will be costlier under forward rate than under the spot rate. If the forward margin is at discount the foreign currency will be cheaper for forward delivery than for spot delivery.
Under direct quotation, premium is added to spot rate to arrive at the forward rate. This is done both purchase and sale transactions. Discount is deducted from the spot rate to arrive at the forward rate.
1. on the same day; or
2. two days later; or
3. some day later; say after a month
Where agreement to buy and sell is made on and executed on the same date, the transaction is known as cash or ready transaction. It is also known as value today.
The transaction where the exchange of currencies takes place two days after the date of the contract is known as the spot transaction. For instance, the contract is made on Monday, the delivery should take place on Wednesday. If Wednesday is a holiday, the delivery will take place on the next day; i.e Thursday.
The transaction in which the exchange of currencies takes place at a specified future date, subsequent to the spot date, is known as a forward transaction. The forward transaction can be for delivery one month or two months or three month, etc. A forward contract for delivery one month means the exchange of currencies will take place after one month from the date of contract and so on.
When forward rate is the same as the spot rate for the currency, it is said to be ‘at par’ with the spot rate. But this rarely happens. More often the forward rate for a currency may be costlier or cheaper than its spot rate. The difference between the forward rate is know as the ‘forward margin’ or ‘swap point’. The forward margin may be either at premium or at ‘discount’ . If the forward margin is at premium, the foreign currency will be costlier under forward rate than under the spot rate. If the forward margin is at discount the foreign currency will be cheaper for forward delivery than for spot delivery.
Under direct quotation, premium is added to spot rate to arrive at the forward rate. This is done both purchase and sale transactions. Discount is deducted from the spot rate to arrive at the forward rate.
