Loading the player...
A:

The forward rate and spot rate are different prices, or quotes, for different contracts. The forward rate is the settlement price of a forward contract, while the spot rate is the settlement price of a spot contract.

A spot contract is a contract that involves the purchase or sale of a commodity, security, or currency for immediate delivery and payment on the spot date, which is normally two business days after the trade date. The spot rate, or spot price, is the current price of the asset quoted for the immediate settlement of the spot contract. For example, say it's the month of August and a wholesale company wanted immediate delivery of orange juice, it will pay the spot price to the seller and have orange juice delivered within 2 days. However, if the company needs orange juice to be available at its stores in late December, but believes the commodity will be more expensive during this winter period due to a higher demand than supply, it cannot make a spot purchase for this commodity since the risk of spoilage is high. Since the commodity wouldn't be needed until December, a forward contract is a better fit for the investment.

Unlike a spot contract, a forward contract is a contract that involves an agreement of contract terms on the current date with the delivery and payment at a specified future date. Contrary to a spot rate, a forward rate is used to quote a financial transaction that takes place on a future date and is the settlement price of a forward contract. However, depending on the security being traded, the forward rate can be calculated using the spot rate.

For example, say a Chinese electronic manufacturer has a large order to be shipped to America in one year. The Chinese manufacturer engages in a currency forward and sells $20 million in exchange for Chinese yuan at a forward rate of $0.80 per Chinese yuan. Therefore, the Chinese electronic manufacturer is obligated to deliver 20 million dollars at the specified rate on the specified date, six months from the current date, regardless of fluctuating currency spot rates.

You might be thinking of how the forward rate is calculated. Investopedia's got you. Read How do I convert a spot rate to a forward rate?

 

RELATED FAQS
  1. How is a share premium account taxed?

    Understand the difference between a spot rate and forward rate. Learn why someone would enter into a contract with a spot ... Read Answer >>
  2. How do I convert a spot rate to a forward rate?

    The spot rate answers the question, "How much would it cost to execute a financial transaction today?" The forward rate answers ... Read Answer >>
  3. What are some securities that have spot rates?

    Learn about the types of assets that have spot rates, and understand how the spot rate is used to determine the fair market ... Read Answer >>
  4. Over what time period should I be looking at the forward rate?

    Read about forward rates and forward prices, how they function, and which rates you should look at based on your own investment ... Read Answer >>
  5. Why is the initial value of a forward contract set to zero?

    Discover why the initial value of a forward contract is set to zero; read about financial mathematics and exchange logic ... Read Answer >>
Related Articles
  1. Trading

    How To Lock In An Exchange Rate

    Currency risk can be effectively hedged by locking in an exchange rate through the use of currency futures, forwards, options, or exchange-traded funds.
  2. Investing

    What is a Forward Contract?

    A forward contract is a customized contract between two parties to buy or sell an asset at a specified price on a future date.
  3. Trading

    Forex: Gauging Forex Market Sentiment With Open Interest

    Examining open interest on currency futures can help you confirm the strength of a trend in forex market sentiment.
  4. Investing

    What Does Contango Mean?

    Contango​ is when the futures price of a commodity is higher than the expected future spot price.
  5. Trading

    Contango Vs. Normal Backwardation

    Learn about the futures curve and what its shape means for hedgers and speculators.
  6. Investing

    3 Strategies to Mitigate Currency Risk (EUFX)

    Discover the often overlooked risk known as currency risk, and learn three strategies to mitigate or eliminate it in your portfolio.
  7. Trading

    The Money Market Hedge: How It Works

    Investopedia explains how to hedge foreign exchange risk using the money market, the financial market in which highly liquid and short-term instruments like Treasury bills, bankers’ acceptances ...
  8. Investing

    Cooking The Books

    To spot the signs of earnings manipulation, you need to know the different ways companies can inflate their figures.
  9. Investing

    What is a Settlement Date?

    A settlement date is the day a security trade must be settled.
  10. Investing

    Commodity Investing 101

    From the orange juice we drink to the gas we use to power our vehicles and heat our homes, commodities play important roles in our daily lives.
RELATED TERMS
  1. Spot Date

    The spot date is the date at which a transaction is settled.
  2. Spot Rate

    The price that is quoted for immediate settlement on a commodity, ...
  3. Forward Points

    The number of basis points added to or subtracted from the current ...
  4. Outright Forward

    A forward currency contract with a locked-in exchange rate and ...
  5. Spot Market

    1. A commodities or securities market in which goods are sold ...
  6. Long Dated Forward

    A type of forward contract commonly used in foreign currency ...
Hot Definitions
  1. Retirement Planning

    Retirement planning is the process of determining retirement income goals and the actions and decisions necessary to achieve ...
  2. Drawdown

    The peak-to-trough decline during a specific record period of an investment, fund or commodity. A drawdown is usually quoted ...
  3. Inverse Transaction

    A transaction that can cancel out a forward contract that has the same value date.
  4. Redemption

    The return of an investor's principal in a fixed income security, such as a preferred stock or bond; or the sale of units ...
  5. Solvency

    The ability of a company to meet its long-term financial obligations. Solvency is essential to staying in business, but a ...
  6. Dilution

    A reduction in the ownership percentage of a share of stock caused by the issuance of new stock. Dilution can also occur ...
Trading Center