The spot market is the place where they trade financial instruments for immediate delivery. Delivery in this context is the exchange of cash for financial assets. These financial instruments include commodities, securities, and currencies. A futures contract is different. The delivery of such products are based on future dates.
Spot Market Explained
Other names for spot markets include cash markets and physical markets. The names come because of the nature of swapping cash for assets at a physical location. The official transfer of money from the buyer to the seller may time in some cases. For stocks, settlement takes T+2 days. Most currency transactions happen on a “Right Now” basis. Futures transactions occur on the “Non-Spot” basis. The buyer and the seller agree on the price in the present, but delivery and transfer of funds occur in a future date.
Futures trade in contracts that are about to expire. Because the buyer and the seller agree to settle the transaction on a specific date, futures trades adopt the name spot trades.
A spot price is the current price of a financial instrument. Buyers and sellers create a spot price by posting the buy and sell orders. In liquid markets, spot prices update and change in the blink of an eye.
Types of Spot Markets
1- Spot Exchange Markets
Spot exchange markets bring together dealers and traders who buy and sell various financial instruments. The exchange provides the volume and current price to all traders. The New York Stock Exchange is an example of a spot exchange market. Traders with access to this market can buy and sell stocks. The Chicago Mercantile Exchange is another example of a spot exchange market.
2- Over-the-Counter Spot Markets
Over-the-counter trades are those that occur directly between the buyer and the seller. A centralized exchange does not support this type of trade. The forex market is the world’s largest over-the-counter spot market. This market averages a daily turnover of $5 trillion.
For over-the-counter transactions, the price is either based on spot or future dates. The terms are not standardized and may be subject to the discretion of the buyer and seller. Over-the-counter stock, transactions are spot trades.
Spot Markets vs. Futures Markets
The futures market is different from the spot market. In futures markets, the asset value is subject to future price movements and the price of storage. In the spot market, existing supply and demand affect the price of the asset. The perishability of a commodity also affects the prices of commodities on a spot market.
Real-World Examples of Spot Market Dealings
Picture an online furniture store in France that offers a 30% discount to its international customers. To qualify for the discount, the customer has to settle the transaction within five business days.
Karen operates an online furniture business in the United States. She sees the offer and decides to purchase about $10,000 worth of office desks for her store. To facilitate the purchase, she must buy euros for immediate delivery. With a EUR/USD exchange rate of 1.1233, she is happy to execute the forex transaction.
The spot price of 1.1233 units delivers her €8,902.34. This spot transaction is subject to a settlement date of T+2. Within two business days, Karen receives her money in Euros. She then proceeds with the purchase of her office desks.
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