Sometimes known as a spot price, the spot rate is the rate that both the buyer and the seller agree to in order to immediately settle a transaction involving some type of security, commodity, or currency. The very nature of the spot rate implies that the settlement is to take place quickly, although completion is rarely at the very moment that the deal is struck. More often, setting a spot rate means that the transaction will be completed within one to two business days of the date that the rate is agreed upon.
Arriving at a spot rate normally involves considering both the current value of the asset and the opportunity for that value to increase within a reasonable period of time. This means that the rate may be identical to the current market value, or it may be higher or lower, depending on how the buyer and seller expect the asset to perform. A seller may accept a spot rate that is lower than the current market value, if there is little hope of selling the asset before the value begins to drop, making it possible to absorb a smaller loss. At the same time, a buyer may be willing to pay a little more than current market value in order to secure an asset that shows promise of increasing significantly in value within a short period of time.
The concept of a spot rate is sometimes confused with the forward date that is found in most futures contracts. While both strategies set prices now that will be settled in the future, the difference is that with a spot rate, the settlement is immediately pending, typically no more than two business days from the trade date. By contrast, a forward date in a futures contract may mean that pricing established today will lead to a settlement of the contract several weeks or months from the trade date.
One of the characteristics of a spot rate is that it is possible to take into account the present value, determine a price that is agreeable to both parties, and immediately lock that price into place. This means that no matter what happens to the marketplace while the transaction is moving toward completion, that spot rate remains the same. Even if something unanticipated happens to dramatically shift that market value within the next twenty-four to forty-eight hours after the rate is established, the transaction continues as if no market shifts of any type occurred.
