Spot Rate: Definition, How it Works, Examples

Key Takeaways

• Spot rate is the price quoted for immediate settlement on a commodity, security, interest rate, or security.

• The obverse of spot rate is the forward rate, which is an agreed-upon price for an asset’s future delivery.

• The spot rate can reliably indicate the relative value of various currencies and plays a crucial role in facilitating investment and trade. 

There are different types of participants in financial markets. While some investors seek future delivery of shares, others prefer the immediate settlement of securities. The latter – the instant delivery of securities — occurs in the spot market. But just what is “spot rate?” Here is the definition, how it works, and examples. 

What is a Spot Rate?

In investing, “spot rate” is basically an asset’s market value at the moment it is quoted. In other words, it is the price quoted for immediate settlement  and delivery on a commodity, security, interest rate, or security.

For an asset available for immediate delivery, the spot rate mirrors real-time market supply and demand. Rates are fluid and change constantly as market conditions fluctuate.

Spot rate also refers to the exchange rate – at the present moment – between two currencies, with immediate settlement and delivery. 

What are Some Factors That Influence Spot Rate?

A spot rate’s value is based in part on the amount that purchasers will pay and the amount that sellers are willing to take, which typically hinges on a variety of factors including supply and demand, current and expected future market value, in addition to factors that can affect the entire market: interest rates, geopolitical events such as wars, and overall market sentiment.

Spot Rate vs. Forward Rates

The obverse of spot rate is the forward rate, also called the futures price, which is an agreed-upon price for an asset’s future delivery.

With spot rate, market occurrences between the transaction’s initiation date and the transfer of funds notwithstanding, the transaction consummates at the agreed upon price.

In fact, the spot rate is employed to determine the forward rate – a future financial transaction price – since an asset’s expected future value depends partly on its current value as well as its risk-free rate and time until maturity. That means that traders can infer an unknown spot rate if they know the future’s price, when the contract matures, and the risk-free rate.

Ultimately, forward rates allow investors and businesses to hedge against currency risk and plot future cash flows. Comparing the spot and forward rates allow market participants to evaluate market expectations concerning future currencies movements and strategize accordingly.

Spot Rate Examples

Here is an example of how spot prices and forward contracts are employed in market transactions. Say that it is September and a wholesaler must make a delivery of fruit. To ensure delivery within two business days, the wholesaler will pay their seller the spot price.

The wholesaler needs the fruit in stores by late January, but also believes that by then the price will increase due to wintertime demand and diminished supply.  In this scenario, a forward contract would make more sense since the fruit is not required right away, and a spot purchase would risk fruit spoilage.

In another example, note that share spot prices are the current value of a company’s market share. For instance, if Apple is trading at $185 per share, that is the share’s spot price. So, in a share spot price example, if an investor seeks 10 shares of Apple at the spot price, they need $1,850 to cover it. After buying the shares, they can sell them at a future date, hopefully at a profit if the share price rose.

In a foreign exchange spot price example, say the spot price of USD/JPY is 143.70, which means it would take 143.70 Japanese yen to buy a U.S. dollar.

A trader takes a short position on the spot price of the pair, believing its value will soon fall.  This is done using what is called a contract for difference (CFD), opening a position to “sell” 1,000 USD/JPY contracts at a price of 10 cents per movement point. If, as anticipated, the price did drop to, say, 143.50, those 20 points of movement would garner some $2,000 (20×0.1×1000).

Why are Spot Rates So Important?

The spot rate can reliably indicate the relative value of various currencies and plays a crucial role in facilitating investment and trade. 

Understanding the concept of spot rate is essential for investors as well as companies that engage in foreign exchanges. Such knowledge can be used to make informed decisions and accurately gauge the value of their assets as well as liabilities.

Monitoring Spot Rates

The spot rate is closely tracked by financial institutions, central banks, and investors globally, since beyond exchange rates, the spot rate affects varying aspects of investment, global trade, and financial decision making.

There are various ways to keep track of the global market and stay atop spot rates, including through the use of currency converters and currency exchange websites. There are some 60 primary global stock exchanges that vary in size and trading volume.

Spot Rates and Investments

Investors who seek to diversify their portfolio can benefit from understanding spot rate’s impact on the U.S. economy overall.  After all, spot rate provides actual market movements, and the study of such rates for a certain period can help when analyzing market trends.

And diversification is essential to successful investing. Spreading capital across varied asset classes helps to mitigate risk and guard against inflation.

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $5000.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

Summary

Spot rates essentially reflect the market supply and demand for a particular asset, in that it is a security’s price as quoted by traders. Such rates constantly fluctuate with market changes, so understanding when to take advantage of them is key.

Spot rate can also be used to determine a security’s forward price and can help with portfolio diversification.