Rather than just sitting down and writing what we think a 'Spot' contract is and how you might go about using one to best effect, as you might expect and in an attempt to flesh out our more colloquial references to them, we have done some research.
We've looked at how others describe them... What regulators think of spot contracts and what they think are it's associated risks and benefits; and we have also looked at how our current clients implement it/them in the course of their day to day currency activities.
So, in tried and tested GCSE fashion, let's begin with the online definition:
"A spot contract, spot transaction, or simply 'spot', is a contract of buying or selling a commodity, security or currency for immediate settlement (payment and delivery) 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, so it differs marginally from the price for other settlement terms and contracts.
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 - and we talk more about that in our next 'CONTRACTS' post in the series which focusses specifically on forward buying.
Threaded throughout PrimeCap.com are links through to explanations and definitions of the contracts we commonly work with. We talk about contracts and sometimes we give broad outlines as to how or when a contract
might be used, but, such are the multitude of ways in which you can combine contracts that it really and truly is a case of arriving at a bespoke, if not unique, solution based on a couple of different things that we identify as important.
One of the most useful things about a spot contract, and one of the main misconceptions about their use, is that you need to have money with us on the very day the contract is struck.
As the above definitions state, spot contracts generally include the provision that delivery of the currency you're buying is two days from the booking date ('T+2').
This is so precisely in order to assist both you and us with the readying, organisation and timely provision of the currencies involved in the exchange.
If you'd simply used your bank's online banking system to send money to Italy, for instance, then you might login and click for the relevant payment to go to the relevant place. This is still firmly and very much the case when using a spot contract.
You just login and put us as the recipient of the GBP sterling amount.
Nowerdays though, such are the improvements to the domestic sending of money, the funds tend to arrive with us immediately.
Yes, this can mean we are not in a position to release your bought currency until the value date of the contract because we have told the institution we're buying your money from that we will pay them in two day's time. This is perhaps as you would expect? but, in certain circumstances we are able to tweak the contract so as to release your bought currency on the day your sold currency arrives with us - so you dont have to worry about any delay at all.
Over time and on the basis that we become more familiar with how long it takes for your bank to send us funds, we might change the terms of your spot/typical booking or simply look to use a contract that reflects or better suits the transaction pattern we come to identify.
The bottom line though is that with a spot contract you are locking in the rate as it is right now, but you're not putting yourself under too much pressure to pay for that purchase because you have 48 hours to get things squared away in terms of paying us.
Our suspicion is that spot contracts allow two days because people used to have to go to their bank in person to instruct settlement and you mightn't be able to go to the back the very same day...that has of course all changed.
When might you use a spot contract?
It is the most commonly used foreign exchange contract because of the certainty it gives on rate and the flexibility it gives on settlement.
You might use a forward contract to simply exchange a foreign currency you have liquid and want realised in a different currency.
We find clients who just want to send living expenses for second homes abroad or to friends and family and businesses paying an invoice they need to settle quickly find spot contracts most useful.
If a client has asked us to watch for a rate, or they hold currency with us and would like us to use our discretion as to when the funds should be exchanged, we might engage the market using a spot contract even though we have funds on account already.
Owing to the fact that it is, by and large, the default contract used in retail currency, the rate of exchange is ever so slightly more competitive on a spot contract than on any other contract. This is because it is the default. Any other contract carries a tiny tiny premium at a wholesale level.
The premium carried isn't sufficiently large to prompt clients to object to using these other contracts, but, when we are left instruction by a client and when settlement timing is not really an issue, we opt to use the default and more competitive spot because...well, why not? It is better/best value for our clients.
If you considering how to exchange a currency and would like some direct verbal advice and guidance then do please get in touch. It's what we're here for.