Just like most industries, the Financial Services business sector has its own specific technical language. Occasionally some of the terms used can cause a little confusion with consumers and people outside of the industry. In the context of foreign exchange, one of those is "spot rate". So, here we’ll demystify the term as related to business and consumer finance.
A common point of reference
When you see a foreign currency exchange rate discussed on the TV or in the newspapers, it usually means a rate that is being used to compare the respective values of two different currencies. So, when the media refers to the value of the Australian Dollar relative to say the Euro, they may express it in terms of the respective buying and selling powers of the two currencies against each other.
In other words, you might see it shown as “A$=€0.6453” - or 1 Aussie Dollar is going to buy a little over half a Euro (illustrative rate only). Of course, when you are shopping around for your business or personal foreign currency exchange, you are likely to see some quite significantly different rates quoted. So, how do the banks, media and governments decide how much currencies are worth against each other? The market rate Governments and the major financial markets have methods of arranging exchange rates between themselves at a given point in time for settlement purposes. This is called the “market rate” and it forms the basis of all forex transactions across the globe. However, in practice this rate is reserved for vast inter-governmental transactions and market setting.
You’ll see it used in the media as a way of trying to track the strength of one currency versus another. It typically isn’t a rate available to an individual business or private consumer. The spot rate When you buy or sell currency, you’ll be able to agree with your provider the exchange rate they will use. Those rates will vary from one provider to another based upon things such as their cost base, their profit requirements and above all, how successful they are in buying or selling currencies in the markets.
The standard ‘spot’ conversion rate is what they’ll offer based on the assumption that delivery of the funds and the transfer will be completed within two working days. A forward rate Quite often, a business or even sometimes a private individual might need a little more certainty about what one currency is going to do against another at some time in the future. For example, if you are buying property overseas and agree a final cash transfer and settlement for 30 days’ time, you may not welcome a large currency movement in the interim which means when you make the final settlement you’ve got to find say 10% more in Australian Dollars than you anticipated at the time you signed the purchase contract in the local currency. One way of protecting yourself against that is to agree a forward exchange contract (FEC) rate for the transaction that will be valid in 30 days’ time. That way you can be sure of your required financial outlay in Australian Dollars in advance and can budget accordingly. If you would like any further confirmation on some of the terms associated with foreign currency transactions, we’d be only too pleased to help!
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