Spot rate and forward rate are the terms used in the context of foreign exchange markets. However there are many differences between spot and forward rate, let’s look at some of those differences –
- In spot rate transaction the settlement of funds or delivery of currency takes place on the second working day from the day of contract while in case of forward rate transactions the settlement of funds or delivery of currency takes place on future date except spot date ( because that would be spot rate).
- Example of calculation of spot rate date is suppose the date of spot deal is 14th April 2014 then settlement date will be 16th April while example of forward rate date is suppose the 3 month forward contract is executed on 14th April then settlement date will be 14th July 2014.
- Forward rate is always either higher or lower than spot rate and it is never same as spot rate because of various factors like time value of money, demand and supply of currency, risk free interest rate, presence of speculators and arbitrageurs and so on.
- If the forward rate is more than spot rate then currency is said to be at premium that is currency will be more expensive in future whereas if forward rate is less than spot rate then currency is said to be at discount that implies currency will be cheaper in future.
- In spot rate there can be only one exchange rate whereas if forward there can be multiple exchange rates like 1 month rate or 2 month rate or 3 month rate and hence one has to be very careful while transacting in forward transaction in currency market.